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KLOCK v. LEHMAN BROS. KUHN LOEB INC.

March 30, 1984

Felix S. Klock
v.
Lehman Brothers Kuhn Loeb Incorporated, Michael Cavanaugh and Geoffrey Horner



The opinion of the court was delivered by: WARD

WARD, District Judge

In May 1978, Felix S. Klock opened an account with Lehman Brothers Kuhn Loeb, Inc. ("Lehman") and authorized Lehman to effect trades in securities and commodities options on his behalf. After suffering significant losses, Klock closed his account in October 1979. Thereafter, on May 19, 1983, he filed this lawsuit, alleging that Lehman and two of its employees, Michael Cavanaugh and Geoffrey Horner, improperly and illegally managed his account and engaged in excessive transactions without his approval. Plaintiff claims that he incurred substantial losses as a result of defendants' conduct. He seeks damages for "churning," for common law fraud and for breach of contract. *fn1" Defendant Lehman moves pursuant to Rules 12(b)(6) and 9(b), Fed. R. Civ. P., for an order of this Court dismissing the complaint primarily on the ground that this action is time-barred by the applicable statute of limitations. *fn2" For the reasons hereinafter stated, Lehman's motion is granted in part and denied in part.

 BACKGROUND

 Plaintiff is, and at all times material to this action was, a resident of Connecticut. Lehman is a member of the New York Stock Exchange and other exchanges, and is registered as a broker-dealer with the Securities and Exchange Commission. The individual defendants were registered representatives employed by Lehman, and are alleged to have acted at all times material to this action within the course and scope of their employment and with the express or apparent authority of Lehman. Jurisdiction over this action is said to arise from 28 U.S.C. §§ 1331, 1332 by reason of both the claims which arise under the laws of the United States and the diversity of citizenship of the parties.

 According to the complaint, Cavanaugh telephoned plaintiff in May 1978 and induced him to open an account with Lehman. At that time, plaintiff entered into an agreement with Lehman pursuant to which Lehman was authorized, in consideration for receiving commissions from plaintiff, to effect securities and options contract transactions on plaintiff's behalf. Plaintiff alleges that from about May 1978 through about October 1979, defendants engaged in such transactions on plaintiff's behalf, without consulting plaintiff or obtaining his approval. During this time defendants allegedly exercised exclusive and total control over plaintiff's account. Plaintiff complains that defendants engaged in unnecessary and objectionable trades during this period in order to earn excessive commissions. As a result of these transactions, according to the complaint, plaintiff suffered losses in the amount of $895,600.57. Additionally, plaintiff was allegedly required to pay margin interest in 1978 and 1979 totalling $93,545.37, plus commissions during this period equal to $216,309.87.

 The complaint was filed on May 19, 1983, and sets forth six Claims for Relief based on these allegations. The First Claim asserts a cause of action under section 10(b) of the Securities Exchange Act, 15 U.S.C. § 78j(b) ("section 10(b)") *fn3" and the rules and regulations promulgated thereunder.Secondly, plaintiff urges that defendants' conduct is actionable as common law fraud. The Third Claim seeks relief for Lehman's alleged breach of contractual obligations to (i) act with due care and diligence with respect to plaintiff's account; (ii) supervise its employees working on plaintiff's account and insure that they acted in plaintiff's best interests; and (iii) act in good faith towards plaintiff. Lehman is charged in the Fourth Claim for Relief with violations of section 20(a) of the Securities Exchange Act, 15 U.S.C. § 78t(a) ("section 20(a)") for breach of its duties as the "controlling person" of the individual defendants. *fn4" Lehman's conduct is alleged, in the fifth claim, to have violated Rule 405 of the Rules of the New York Stock Exchange ("NYSE Rule 405"), and, in the Sixth, to contravene Section 2 of Articles III of the Rules of Fair Practice of the National Association of Securities Dealers (the "NASD Rule").

 In a Seventh, and final, Claim for Relief, plaintiff seeks damages for breach of an alleged contract for the exchange of tax-free municipal bonds. Plaintiff asserts that, after opening his account with Lehman, he delivered to defendants, at defendants' request, tax-free municipal bonds valued at approximately $350,000.00 for the purpose of exchanging them for bonds of like quality but higher yield. Defendants allegedly breached this agreement by using these bonds as collateral for margin coverage, which use enabled defendants to purchase additional securities for plaintiff's account. As a result of the large losses in plaintiff's account, plaintiff claims he was forced to liquidate the bonds for $341,200.00, and to use this entire amount to pay off a portion of his margin debt. Accordingly, plaintiff seeks additional damages in the amount of $341,200.00 by reason of this alleged breach of contract.

 Lehman has filed a motion for an order of this Court dismissing the complaint pursuant to Rules 12(b)(6) and 9(b), Fed. R. Civ. P. In support of the Rule 12(b)(6) ground, Lehman argues that plaintiff failed to file this lawsuit within the relevant statutory period, and that the complaint otherwise fails to state a claim upon which relief can be granted. Relying on Rule 9(b), Lehman also seeks dismissal of the fraud claims on the ground that plaintiff has failed to plead fraud with the requisite particularly.

 DISCUSSION

 A. The Fraud Claims

 Lehman argues that plaintiff's claims under sections 10(b) and 20(a) of the Securities Exchange Act, as well as his claims for common law fraud are barred by the applicable statute of limitations. According to Lehman, this Court must apply the relevant statute of limitations of the state of plaintiff's residence, Connecticut. Lehman argues that the limitations period prescribed by the appropriate Connecticut statute is at most three years, and that the instant complaint was not filed within that time period.

 The Securities Exchange Act prescribes no period of limitations for actions brought under sections 10(b) or 20(a). In such situations, federal courts refer to the relevant statute of limitations of the forum state, in this instance, New York. This reference must include application of New York's "borrowing statute," N.Y. Civ. Prac. Law § 202. *fn5" See, e.g., Cope v. Anderson, 331 U.S. 461, 465, 91 L. Ed. 1602, 67 S. Ct. 1340 (1947); Armstrong v. McAlpin, supra, 699 F.2d at 86, 89; Industrial Consultants, Inc. v. H.S. Equities, Inc., 646 F.2d 746, 747 (2d Cir. 1981), cert. denied, 454 U.S. 838, 70 L. Ed. 2d 120, 102 S. Ct. 145 (1981); Stull v. Bayard, 561 F.2d 429, 431 (2d Cir. 1977), cert. denied, 434 U.S. 1035, 54 L. Ed. 2d 783, 98 S. Ct. 769 (1978); Arneil v. Ramsey, 550 F.2d 774, 779-80 (2d Cir. 1977); Sack v. Low, 478 F.2d 360, 365-68 (2d Cir. 1973). Under that statute, a lawsuit instituted in New York by a non-resident based upon a cause of action accruing in a state other than New York is time-barred if the statute of limitations of either that state or New York had expired prior to the institution of the lawsuit.

 In actions alleging fraudulent violations of the federal securities laws, the Second Circuit has consistently adopted state statutes of limitations for actions based upon common law fraud. See, e.g., Armstrong v. McAlpin, supra, 699 F.2d at 86; Stull v. Bayard, supra, 561 F.2d at 431; Klein v. Shields & Co., 470 F.2d 1344, 1346 (2d Cir. 1972); Klein v. Auchincloss, Parker & Laboratories, Inc. v. Philippine National Bank, 426 F.2d 1023, 1025 (2d Cir. 1970). But see Berry Petroleum Co. v. Adams & Peck, 518 F.2d 402, 409 (2d Cir. 1975) (applying Texas law). *fn6" Ordinarily, then, the six-year limitations period established in N.Y. Civ. Prac. Law § 213(8) for "an action based on fraud" would apply to securities fraud suits brought in New York. *fn7" However, the Second Circuit has held repeatedly that New York's "borrowing statute," applies to an action for fraud based upon violations of the federal securities laws instituted in New York by a non-resident and that such an action accrues in the state of the plaintiff's residence. See, e.g., Armstrong v. McAlpin, supra 699 F.2d at 89; Industrial Consultants, Inc. v. H.S. Equities, Inc., supra, 646 F.2d at 747; Stafford v. International Harvester Co., 668 F.2d 142, 151 (2d Cir. 1981); Robertson v. Seidman & Seidman, 609 F.2d 583, 586-87 (2d Cir. 1979); Stull v. Bayard, supra, 561 F.2d at 431; Arneil v. Ramsey, supra, 550 F.2d, at 779-80; Sack v. Low, supra, 478 F.2d at 365-66. The New York courts are in accord. See e.g., Knieriemen v. Bache Halsey Stuart Shields, Inc., 74 A.D. 2d 290, 296, 427 N.Y.S.2d 10, 14 (1st Dept. 1980), appeals dismissed, 50 N.Y.2d 1021, 410 N.E.2d 745, 431 N.Y.S.2d 812 (1980); 51 N.Y.2d 970, 416 N.E.2d 1055, 435 N.Y.S.2d 720 (1980); Prefabco Inc. v. Olin Corp., 71 A.D.2d 587, 588, 418 N.Y.S.2d 432, 433 (1st Dept. 1979).

 Plaintiff argues that these decisions are not controlling in this case, and that this Court should apply the six-year limitations period prescribed by N.Y. Civ. Prac. Law § 213(8). He contends that two of the agreements executed by the parties contain choice of law provisions which provide that New York law should govern. Plaintiff refers specifically to the "Customer's Margin Agreement," dated August 1, 1978, and the "Client's Option Agreement," dated October 20, 1978, each of which contain a clause providing that "[t]his agreement" shall be governed by the laws of the State of New York. According to plaintiff, these choice of law provisions nullify the effect of New York's "borrowing statute," and require this Court to apply the New York statute of limitations for common law fraud.

 Regardless of whether these clauses, which are expressly applicable only to the particular agreements in which they are found, can be said to govern the entire relationship between the parties, it has been held in New York that a contractual choice of law provision governs only a cause of action sounding in contract. This very issue was addressed by the Appellate Division, First Department, in Knieriemen v. Bache Halsey Stuart Shields, Inc., supra, 74 A.D.2d at 293, 427 N.Y.S.2d at 12-13. In that case, the plaintiff, a resident of Louisiana, sued a New York brokerage firm to recover for alleged breaches of contract, negligence, fraud and churning in connection with plaintiff's commodity trading account. In determining that New York's "borrowing statute" applied to plaintiff's churning claim, the court rejected plaintiff's contention that the contractual provision selecting New York law as controlling mandated application of New York's statute of limitations. The court explained:

 The customer's agreement that plaintiff signed with the defendant when their business relationship commenced recited that "[t]his contract shall be governed by the laws of the State of New York". Relying at least in part on this recitation the trial court held that New York law should apply to all of the causes of action. The defendant maintains that Louisiana law should have been applied to the tort causes of action.

 That the parties agreed that their contract should be governed by an expressed procedure does not bind them as to causes of action sounding in tort (see Fantis Foods v. Standard Importing Co., 63 A.D.2d 52, 406 N.Y.S.2d 763 revd. on other grounds, 49 N.Y.2d 317, 425 N.Y.S.2d 783, 402 N.E.2d 122), and, as to the tort causes of action, there is no reason why all must be resolved by reference to the law ...


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