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HELLER v. ROTHSCHILD

April 3, 1986

CHARLES W. HELLER, Plaintiff,
v.
L.F. ROTHSCHILD, UNTERBERG, TOWBIN and LAWRENCE F. RICE, Defendants



The opinion of the court was delivered by: HAIGHT

HAIGHT, District Judge:

 In this case, plaintiff Charles W. Heller alleges the churning of his investment account, in violation of the federal securities laws prohibiting fraud. The individual defendant Lawrence F. Rice, is the broker with whom plaintiff dealt. Rice was employed by the brokerage firm of L. F. Rothschild, Unterberg, Towbin ("Rothschild"), the latter's asserted liability being that of a "control person" over Rice. Securities Exchange Act of 1934, 15 U.S.C. § 78t. The complaint alleges that plaintiff maintained a brokerage account with Rothschild from October 1984 through May 1985.

 Defendants moved to dismiss the original complaint for failure to allege fraud with that degree of particularity required by Rule 9(b), F.R.Civ.P. Plaintiff did not resist that motion. Instead, he filed and served an amended complaint. Defendants now move to dismiss that pleading, on the ground that the amendments do not cure the Rule 9(b) deficiencies. Defendants also ask that the Court deny leave to replead.

 Churning is a deceptive device within § 10(b) of the 1934 Act and Rule 10b-5 for which a private cause of action for damages will lie. Churning occurs when a securities dealer induces transactions in his customer's account which are contrary to the customer's instructions, disproportionate to the size and character of the account, and indulged in to create commissions for the dealer. Newburger Loeb & Co., Inc. v. Gross, 563 F.2d 1057, 1069 (2d Cir. 1977), cert. den., 434 U.S. 1035, 54 L. Ed. 2d 782, 98 S. Ct. 769 (1978). More recently, the Second Circuit has characterized "churning" as a synonym for "overtrading," defining the practice as "the excessive rate of turnover in a controlled account for the purpose of increasing the amount of commissions." Armstrong v. McAlpin, 699 F.2d 79, 90 (2d Cir. 1983).

 Because of a charge of churning is a charge of fraud, the complaint must comply with Rule 9(b). Todd v. Oppenheimer & Co., Inc., 78 F. R. D. 415, 423-24 (S.D.N.Y. 1978). "To establish a claim for churning a plaintiff must plead and prove (1) that the trading in the account was excessive in light of his investment objectives, (2) that the broker exercised control over the account, and (3) that the broker acted with intent to defraud or with willful and reckless disregard for the interests of his client." Moran v. Kidder Peabody & Co., 609 F. Supp. 661, 666 (S.D.N.Y. 1985).

 It is generally held that "conclusory allegations that defendant's conduct was fraudulent or deceptive are not enough," Decker v. Massey Ferguson, Ltd., 681 F.2d 111, 114 (2d Cir. 1982); and that even though the rule requiring particularity in pleading "is relaxed as to matters particularly within the adverse party's knowledge, the allegations must then be accompanied by a statement of the facts upon which the belief [of fraudulent conduct] is founded." Segal v. Gordon, 467 F.2d 602, 608 (2d Cir. 1972). In a case of alleged churning, the plaintiff "must set forth facts that allow the determination of whether or not trading was excessive." Moran, supra, at 666. Discovery in aid of fleshing out a pleading alleging fraud is not favored. Segal, supra, at 609; see also Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 741, 44 L. Ed. 2d 539, 95 S. Ct. 1917 (1975).

 With these principles in mind, I consider the amended complaint in the case at bar.

 I agree with the defendants that the amended complaint does not sufficiently allege the dialogue between the parties, and the nature of their relationship.

 As noted supra, the first element of a claim for churning is that the trading in the account was excessive in the light of the plaintiff's investment objectives. Subsumed within this element are the precise instructions given by the investor to the broker, and the responses made by the broker to the investor, upon which the latter claims to rely. Even though it is the broker's declarations and actions which are said to be fraudulent, it is important to know what the investor said to the broker to elicit those responses, particularly since fraud may consist of omissions as well as affirmative statements. In order that a broker and his employer may adequately comprehend and defend against the charge of fraud, a plaintiff alleging fraud by churning should allege specifically what instructions he gave to the broker or other representative of the corporate defendant; to whom those instructions were given; on what dates they were conveyed; and whether they were oral, in writing, or both. The plaintiff in such an action should allege, with comparable particularity, what his own investment experience was, and what information he conveyed on that subject to the broker, with comparable detail.

 Secondly, the plaintiff should allege with comparable particularity the responses or assurances made by the broker or on behalf of the brokerage house which plaintiff alleges were fraudulent.

 The second element relates to whether or not the broker exercised control over the account. Most frequently, this involves whether or not the broker had discretionary control over the investor's account. If that is the fact, the investor must specifically allege it to be so. Judge Sweet so held in Moran, supra, at 666, going on to observe:

 
Where a customer has the independent capacity to accept or reject his broker's recommendations, he cannot accuse his broker of having control of his account even if he habitually follows his broker's recommendations.

 For that proposition, Judge Sweet cited Follansbee v. Davis, Skaggs & Co., 681 F.2d 673 (9th Cir. 1982). Follansbee contemplates two sorts of account controlled by a broker:

 
If a broker is formally given discretionary authority to buy and sell for the account of his customer, he clearly controls it. Short of that, the account may be in the broker's control if his customer is unable to evaluate his ...

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