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FROTA v. PRUDENTIAL-BACHE SECS.

July 16, 1986

FERNANDO S.G. FROTA and MARIA CARMEN FROTA, Plaintiffs,
v.
PRUDENTIAL-BACHE SECURITIES, INC., AHMED HUSSEIN and JOHN F. RASWEILER, Defendants



The opinion of the court was delivered by: CONNER

OPINION AND ORDER

CONNER, D.J.:

 Plaintiffs Fernando S.G. Frota and Maria Carmen Frota ("the Frotas") brought this action against Prudential-Bache Securities, Incorporated ("Prudential-Bache"), Ahmed Hussein ("Hussein"), their broker at Prudential-Bache. and John F. Rasweiler (" Rasweiler"), Hussein's supervisor, alleging violations of section 10(b) of the Securities Exchange Act of 1934 ("the '34 Act"), 15 U.S.C. § 78j(b) (1982), Securities and Exchange Commission rule 10b-5, 17 C.F.R. § 240.10b-5 (1985), the Racketeer Influenced and Corrupt Organizations Act ("RICO"). 18 U.S.C. §§ 1961-1968 (1982), and the laws of the state of New York. Subject matter jurisdiction is predicated upon section 27 of the '34 Act, 15 U.S.C. § 78aa (1982), section 1964 of RICO, 18 U.S.C. § 1964 (1982), the diversiry of citizenship of the parties, and the doctrine of pendent jurisdiction.

 This matter is now before the Court on defendants' motion to dismiss plaintiffs complaint pursuant to rule 9(b), Fed. R. Civ. P. for failure to plead fraud with particularity, and pursuant to rule 12(b)(6), Fed. R. Civ. P., for failure to state a claim upon which relief can be granted. For the reasons set forth below, plaintiffs' complaint is dismissed with leave to replead as indicated.

 Background

 On a motion to dismiss, the Court must accept as true the facts alleged in the complaint. See Cruz v. Beto, 405 U.S. 319, 322, 31 L. Ed. 2d 263, 92 S. Ct. 1079 (1972) (per curiam); Joyce v. Joyce Beverages, Inc., 571 F.2d 703, 706 (2d Cir.), cert. denied, 437 U.S. 905, 57 L. Ed. 2d 1135, 98 S. Ct. 3092 (1978). Accordingly, for the purposes of this motion, the relevant facts are as follows:

 In November 1981, the Frotas opened a so-called "discretionary account" at Prudential-Bache, over which Hussein, their broker, exercised complete control. Between November 1981 and January 1982, the Frotas transferred a portfolio valued at $2,771,635 from the Chase Manhattan Bank in Switzerland to the Prudential-Bache account. They withdrew $347,000 for their own use; the remaining $2,424,635 was managed and invested solely by Hussein.

 Between November 1981 and June 1985, a period of approximately 920 trading days, Hussein made 1,224 purchases and sales of securities for the Frotas' account. Hussein generated $1,900,000 in commissions and more than $2,000,000 in margin charges. When the account was finally liquidated in June 1985, only $69,000 remained. Of the 1,224 transactions for the Frotas' account, 200 were purchases and sales of the same security in a single day; 700 were purchases and sales of the same security within a 30-day period; 165 were purchases and sales of securities for which Prudential-Bache was the sole market-maker.

 Plaintiffs' complaint asserts three claims against defendants. Plaintiffs' first claim charges defendants with violations of section 10(b) and rule 10b-5. Plaintiffs allege that defendants made misrepresentations and omissions, engaged in excessive, unauthorized and unsuitable trading, and churned plaintiffs' account. Plaintiffs' second claim charges defendants with violating RICO, and alleges as predicate acts violations of the mail fraud statute, the wire fraud statute, and the federal securities laws. Finally, plaintiffs' third claim charges defendants with common law fraud and breach of fiduciary duty.

 As noted above, defendants have moved to dismiss the complaint against them. Defendants advance the following grounds in support of their motion to dismiss plaintiffs' federal securities claim: (1) plaintiffs have not specified the alleged misrepresentations and omissions or the circumstances under which they were made with sufficient detail to satisfy rule 9(b), Fed. R. Civ. P.; (2) to the extent that the alleged misrepresentations consist of assurances that plaintiffs' account would be "properly and prudently managed" they constitute non-actionable "puffing"; (3) to the extent that plaintiffs "unsuitability" claim is based on the New York Stock Exchange ("NYSE") "Know Your Customer" rule NYSE rule 405, or the National Association of Security Dealers ("NASD") "Suitability" rule, NASD Rules of Fair Practice art. III, §§ 1, 2, 15(a), 18, it fails to state a claim because no private right of action exists for violations of those rules; (4) to the extent that the securities claim is based on "unauthorized trading," it fails to state a claim or to comply with rule 9(b); and (5) plaintiffs have not properly pleaded the elements of a claim for churning. In support of their motion to dismiss plaintiffs' RICO claim, defendants advance the following grounds: (1) plaintiffs have not pleaded the underlying fraud with particularity; (2) Prudential-Bache and Rasweiler cannot be held vicariously liable for a RICO violation; (3) Prudential-Bache cannot be both a RICO defendant and the RICO enterprise; and (4) plaintiffs have not adequately alleged a pattern of racketeering activity. Finally, defendants argue that plaintiffs' common law claims should be dismissed because plaintiffs have not pleaded the fraud with particularity.

 Discussion

 A. The Securities Count

 The first of plaintiffs' three counts is a claim under the anti-fraud provisions of the federal securities laws. This count is far from a model of clarity, and it is difficult to discern the precise basis for the securities claim. Construed generously, it suggests four separate bases: (1) misrepresentations and/or omissions of material fact, Complaint PP 12-13, 18-21; (2) "unauthorized" trading. id. PP 15, 22-25; (3) "unsuitable" trading, id. PP 15, 25-27; (4) churning, id. PP 15, 22-28. Defendants have attacked the sufficiency of each basis for the securities count. I have carefully examined plaintiffs' complaint, and have concluded that the ...


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