The opinion of the court was delivered by: LOWE
MEMORANDUM OPINION AND ORDER
This is an action based on the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. §§ 78a et seq.,
in which plaintiffs seek damages based on the following claims of wrongdoing: (1) excessive trading ("churning");
(2) unsuitable recommendations as to the purchase and sale of stock;
(3) fraudulent misrepresentations and omissions in the opening of a margin account and options account;
and (4) common law fraud.
Defendant E. F. Hutton & Company, Inc. ("Hutton") has moved, pursuant to Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure, for an order dismissing the complaint for lack of particularity in pleading fraud and for failure to state a claim for which relief may be granted, respectively. For the reasons set forth below, defendant Hutton's motion is denied in part and granted in part. Plaintiffs' request for an award of costs and attorney's fees connected with the motion is denied.
Plaintiffs Betty Zaretsky and Morton Zaretsky ("the Zaretskys") allege that on or about February 14, 1977, they opened a brokerage account with defendant Hutton and that they engaged in various purchases and sales of securities through defendant Tom Hanlon ("Hanlon"), a registered representative employed by Hutton as an Account Executive.
They claim that at the time the account was opened, they informed defendant Hanlon "that they were placing their entire life's savings of some $ 25,000 into his care for the purpose of conservative investment and to generate some extra income to augment their social security allowance" upon their retirement.
On or about May 12, 1978, plaintiffs shifted their account from Hutton to defendant Advest Inc. ("Advest") in order to follow the registered representative, Hanlon, who had changed employment from Hutton to Advest.
There they made various purchases and sales of securities, through defendant Hanlon, until November 1978.
Count 1 of their complaint alleges that Hanlon engaged in 147 separate purchases and sales from February 1977 to November 1978.
Plaintiffs claim that all of those transactions were initiated and recommended by Hanlon, "who exercised effective control over the account;"
that the transactions were "excessive in size and frequency in light of the character" of the account;
and that they constituted the fraudulent practice of churning proscribed under § 10(b) and Rule 10b-5.
Plaintiffs further maintain in count 1 that the brokerage firms, Hutton and Advest, are liable to them as controlling persons under § 20 of the Exchange Act, 15 U.S.C. § 77o ;
that Hutton and Advest "had a duty to exercise due diligence" and that they "wilfully, intentionally and in callous and reckless disregard of its (sic) fiduciary duty to its (sic) customers, and in violation of the rules of the New York Stock Exchange and the National Association of Securities Dealers failed to supervise plaintiffs' account and the transactions therein;"
and that Hutton and Advest knew or should have known that fraudulent activity was taking place with respect to plaintiffs' account but failed to institute appropriate supervisory procedures and internal controls, thereby participating in the fraud.
In count 2 of the complaint, plaintiffs claim that defendant Hanlon made unsuitable recommendations to plaintiffs in the purchase and sale of securities; that he "failed to make reasonable inquiry concerning plaintiffs' investment objectives, financial situation and needs;"
that defendants Hutton and Advest, jointly and in concert, "intentionally and wilfully induced unsuitable purchases and sales of options in plaintiffs' account;"
and that Hutton and Advest wilfully and intentionally failed to supervise plaintiffs' account in violation of the Rules of Fair Practice of the National Association of Securities Dealers and the rules of the New York Stock Exchange.
Count 3 of the complaint
alleges that defendant Hanlon made untrue statements of material fact as to the opening of a margin account and as to the purchase and sale of options, while omitting material facts necessary, in light of the circumstances in which they were made, to make the statements made not misleading.
It is claimed that Hutton and Advest, jointly and in concert, "induced margin and option transactions through the use of untrue statements of material fact" and wilfully and intentionally failed to supervise plaintiffs' account in violation of § 10(b) and Rule 10b-5 of the Exchange Act.
Count 4 reasserts the churning allegations contained in counts 1, 2, and 3 as a claim for common law fraud on the part of each defendant and for breach of fiduciary duty by defendants Hutton and Advest.
On each count plaintiffs ask damages of $ 24,664.24 for commissions, fees, taxes and margin interest paid to defendants.
They also seek punitive damages of $ 1,000,000 on the common law fraud claim.
Defendant Hutton has moved for:
(1) dismissal of counts 1-3 on the grounds that said counts do not allege actual damages as required by § 28(a) of the Exchange Act, 15 U.S.C. § 78bb;
(2) dismissal of counts 1-4 on the grounds that said counts fail to allege fraud with particularity as required by Rule 9(b) of the Federal Rules of Civil Procedure;
(3) dismissal of the claim for punitive damages for failure to state a claim for which this Court can grant relief; and
(4) dismissal of count 4 alleging common law fraud on the grounds that the Court lacks jurisdiction over the subject matter.
Since the Court has before it matters outside the pleadings, the motion to dismiss for failure to state a claim must be treated as one for summary judgment pursuant to Rules 12(b) and 56 of the Federal Rules of Civil Procedure.
See Carter v. Stanton, 405 U.S. 669, 671, 92 S. Ct. 1232, 1234, 31 L. Ed. 2d 569 (1972); Keating v. BBDO International, Inc., 438 F. Supp. 676, 679-80 (S.D.N.Y. 1977).
Under Rule 56, the court does not sit as a trier of fact, but, based on the pleadings, exhibits and affidavits before it, determines whether there are genuine issues of material fact alleged. See FLLI Moretti Cereali v. Continental Grain Co., 563 F.2d 563, 566 (2d Cir. 1977), citing United States v. Bosurgi, 530 F.2d 1105 (2d Cir. 1976). Hutton, the moving party, must present evidence that establishes the absence of factual matters in dispute. See Adickes v. S.H. Kress & Co., 398 U.S. 144, 157, 90 S. Ct. 1598, 1608, 26 L. Ed. 2d 142 (1970); Heyman v. Commerce and Industry Insurance Co., 524 F.2d 1317, 1320 (2d Cir. 1975). If the evidence presented by the parties is subject to conflicting interpretations, or reasonable people might differ as to its significance or weight, summary judgment is improper. See Robertson v. Seidman & Seidman, 609 F.2d 583, 591 (2d Cir. 1979); Doe v. United States Civil Service Commission, 483 F. Supp. 539, 555 (S.D.N.Y. 1980).
Hutton contends that the counts alleging security law violations should be dismissed because plaintiffs do not allege "actual damages" as required by § 28 of the Exchange Act. In support of this contention, defendant Hutton points out that plaintiffs' account showed a net profit of $ 11,755.10 before it was transferred to Advest in May, 1978.
The measure of damages proposed by defendant net loss or gain in value of the portfolio at the time it left Hutton's control does not reflect the claims asserted by plaintiffs. First, the proper measure of damages under the count for churning is not the change in market value of a portfolio but the amount of commissions, fees, interest and taxes paid to defendant because of illegal activity.
The restitution measure of damages is utilized in churning cases where it is impossible to know what securities would have been in the account but for ...