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BAUM v. PHILLIPS

December 8, 1986

MANFRED BAUM, RUTH BAUM, RICHARD BECK IRA BROWN, JOEL DAVID AND JOANN DAVID, ANDREW HADJANDREAS AND HELEN HADJANDREAS, ABE KLEIN AND RENA KLEIN, HERBERT LOWENTHAL, AND HELEN SCIRE, Plaintiffs, and JUDITH AND ROGER HURCOMB AND LARRY J. KORNHABER: Plaintiffs-Intervenors,
v.
PHILLIPS, APPEL & WALDEN, INC., HAROLD ASCH, AND MERRILL LYNCH, PIERCE FENNER & SMITH, INC. Defendants



The opinion of the court was delivered by: LEISURE

LEISURE, District Judge :

This action arises under § 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b) (1983 & Supp. 1986), and Rules 10b-5 and 10b-16 promulgated thereunder, 17 C.F.R. § 240-10b-5 and 10b-16 (1986); New York Stock Exchange Rule 431; §§ 7, 15, 9(a)(2) and 20(a) of the Exchange Act, 15 U.S.C. §§ 78g, 78o, 78i(a)(2) and 78a (1983 & Supp. 1986); and § 17(a) of the Securities Act of 1933 (the "Securities Act"), 15 U.S.C. 77q(a) (1983). The Court's jurisdiction is invoked pursuant to 15 U.S.C. §§ 77v and 78aa. The complaint also sets forth claims pursuant to 18 U.S.C. §§ 1961-68 (1979 & Supp. 1986), known as the Racketeer Influenced and Corrupt Organizations Act ("RICO"), and pendent state law claims of fraud, breach of fiduciary duty and breach of contract.

 FACTUAL BACKGROUND

 Briefly stated the facts are as follows: this action was commenced in September of 1981 by twelve customers of Harold Asch ("Asch"), a registered representative employed by the brokerage house of Phillips, Appel & Walden, Inc. ("PAW"). The plaintiffs brought their complaint against Asch, PAW and Merrill Lynch, Pierce, Fenner & Smith, Inc. ("Merrill Lynch"), which was the clearing agent for PAW. Subsequently three more customers of Asch intervened with an identical complaint. The fifteen complainants shall be referred to hereinafter collectively as plaintiffs. *fn1"

 The Complaint relates to a period of approximately two months in July and August of 1981 wherein it is alleged that Asch, pressured by the threat of personal stock market losses in excess of one million dollars, engaged in a series of fraudulent schemes involving the defendant stock brokerage firms, resulting in multi-million dollar losses to the plaintiffs. Plaintiffs allege a premeditated scheme by Asch, PAW and Merril Lynch to defraud plaintiffs in connection with their holdings in Pittsburgh-Des Moines ("PDM") common stock. In essence, plaintiffs allege that defendants manipulated the trading of PDM common stock and thereby willfuly violated the aforesaid anti-fraud provisions of the federal securities laws.

 Plaintiffs, other than Ruth Baum, each had a margin account with PAW prior to the events giving rise to this lawsuit in July and August of 1981. (Affidavit of John Starr, sworn to on Feb. 7, 1985, P 2) ("Starr Aff."). Asch was the stockbroker employed by PAW who serviced plaintiffs' accounts. (Affidavit of Burton Cavallo, sworn to on Feb. 7, 1985, P 3) ("Cavallo Aff."). Beginning in 1979, Merril Lynch acted as the clearing broker for PAW. (Cavallo Aff., P 3). As clearing broker, Merrill Lynch was responsible for much of PAW's required recordkeeping. Merrill Lynch also lent money to customers of PAW, including plaintiffs, to purchase securities on margin. Id. However, Merrill Lynch did not have any direct dealings with plaintiffs. Id. at P 4. Plaintiffs, without exception, placed each of their orders for securities trades through PAW and it was PAW which executed those trades. Id.

 In 1981, all plaintiffs excluding Ruth Baum held the common stock of PDM in their margin accounts with PAW, and, in a number of instances, other securities as well. See Affidavit of Stephen J. Cucchia, sworn to on Feb. 7, 1985, P 15) ("Cucchia Aff."). Asch also maintained two margin accounts (one in his name and one in the name of his wife) and was heavily invested in PDM. (Cuchia Aff., P 19). Originally, the investments in PDM were highly successful. A number of plaintiffs and Asch used the buying power generated by the rise in PDM to buy still additional investments in PDM.

 PDM is listed on the American Stock Exchange and has historically been thinly traded. By January 1981, the price of PDM had reached a record high of about $60.00 per share. (Affidavit of Harold Asch, sworn to on April 3, 1985, P 5) ("Asch Aff."). At this time, Asch owned or controlled in customer's accounts approximately 150,000 shares of PDM stock. (Asch Answer to Complaint, P 1) ("Asch Answer"). The amount of stock controlled by Asch constituted a substantial block of PDM. On an average, no more than approximately a few hundred shares per day passed hands. (Complaint, P 14(c); Asch Aff., P 3). Thus, sale by Asch or any of his customers of a few hundred or more shares of PDM could have a significant effect on the market price of PDM. (Complaint, P 14(d); Asch Aff., P 4).

 Commencing January 20, 1981, the market price of PDM began to decline. (Complaint, P 14(e); Asch Answer, P 1). By early July 1981, the decline became precipitous, causing the accounts of Asch and plaintiffs to drop below the 30% margin requirements of Merrill Lynch and thereafter below the 25% equity levels required by the New York and American Stock Exchanges. (Memorandum of Law submitted on behalf of Harold Asch, p. 3) ("Asch Memo."). Concerned about their losses and impending margin calls, plaintiffs ordered the sale of a portion of their respective PDM shares, so that none of the individual accounts would be adversely affected by the wholesale selling of any one individual account.

 Plaintiffs allege that PAW had "inside" information that at 1:00 PM on July 23, 1981, PDM would report improved earnings, and for that reason PAW sought to purchase a block of 60,000 shares from the plaintiffs, collectively, through Asch, prior to the release of the aforesaid information and without disclosing the "inside" information to plaintiffs. The plaintiffs allegedly ordered the sale of their shares in connection with the block. However, the block was not assembled and the sale never occurred. (Complaint, PP 19, 20).

 The Complaint next alleges that defendants thereafter undertook to prevent plaintiffs from selling their shares of PDM until the market price was sufficiently depressed that a corrective rebound was assured. (Complaint, P 24). PAW and Merrill Lynch are alleged to have violated margin requirements by failing to liquidate plaintiffs' accounts when they fell below margin requirements. (Complaint, P 25(a)-(b)). PAW and Merrill Lynch are further alleged to have depressed the market price of PDM by means of (1) sales by Merrill Lynch "in an effort to manipulate the market price of the stock downward;" and (2) a plan by Merrill Lynch and PAW to prevent their employees from buying PDM. (Complaint, PP 26(a)(b)).

 Harold Asch is alleged to have participated in this scheme by having (1) "refused to effectuate and/or sought to discourage" orders from plaintiffs for the sale of PDM; (2) advised plaintiffs to sell the other securities in their accounts and/or sold the other securities without authorization; and (3) advised plaintiffs to buy yet more PDM. However, it is not alleged that plaintiffs took any action based upon Asch's advice. Rather, the testimony of plaintiffs is that each of them remained intent upon selling their shares of PDM.

 Plaintiffs allege that, as a result of defendants' scheme, the price of PDM fell to $22.00 on the American Stock Exchange, and plaintiffs' shares were sold to meet the margin calls. (Complaint, PP 27-28). But for the scheme of PAW and Merril Lynch, plaintiffs contend that their shares would have been sold at about $35.00 per share. (Complaint, P 29).

 PAW and Merrill Lynch counter that the only forseeable result of such a drop, and the result that actually occurred, was that Merrill Lynch was left with unsecured margin debt in excess of $213,000.00 owed to it by Asch and plaintiffs. It is further claimed that none of of the aforementioned sum has yet been recovered. (Cucchia Aff., PP 6, 8).

 Asch answered the Complaint in July of 1982 and cross-claimed against PAW and Merrill Lynch. ("Cross-Claims"). Asch acknowledged most of plaintiffs' allegations, denying only those directed against him, but claimed that PAW and Merrill Lynch were responsible for the damages alleged by plaintiffs. Asch's allegations are patterned after those of plaintiffs, except that he denies that he failed to effectuate orders. (Cross-Claims, P 11). Asch describes himself as having been "unwittingly made a party to a scheme and conspiratorial plan of defendants PAW and Merrill Lynch." (Cross-Claims, P 37). However, the only allegations in the Cross-Claims related to the securities in Asch's own accounts are allegations that mimic the Complaint. Asch alleges that his account was undermargined throughout July of 1981 (Cross-Claims, P 34), and that when on July 24, 1981, he requested PAW and Merrill Lynch to sell a block of 100,000 shares of PDM owned by Asch and his customers, he was refused. Asch's Cross-Claims cite the same sections of the Securities Act and Exchange Act as plaintiffs' Complaint. PAW and Merrill Lynch contend that, stripped of supposition and conclusory allegation, Asch's claim readily reduces to one of nonfeasance.

 MOTIONS

 After the close of discovery, defendants PAW and Merrill Lynch each submitted motions for judgment on the pleadings, or, in the alternative, for summary judgment, asking the Court to dismiss the Complaint and Cross-Claims in their entirety for failure to state any claim arising under the federal securities laws. In addition, Merrill Lynch has filed a Motion for Summary Judgment for Payment of Debit Balances against plaintiffs and Asch. Plaintiffs (with the exception of Dr. Helen Scire) have filed motions in opposition and have cross-moved for Judgment on the Pleadings against all defendants. A separate affidavit and memorandum of law have been submitted on behalf of Dr. Scire, her sole allegation of fraud being that Asch breached his assurance that he would sell her shares of PDM and instead sold the non-PDM securities which she maintained in her account.

 The motions submitted by defendants rest, in part, on the grounds that plaintiffs' allegations do not aver with sufficient particularity the events giving rise to any alleged fraud. Rule 9(b) of the Federal Rules of Civil Procedure provides that "[i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." The Second Circuit has held that "mere conclusory allegations to the effect that defendant's conduct was fraudulent or in violation of Rule 10b-5 are insufficient." Shemtob v. Shearson, Hammill & Co., 448 F.2d 442, 444 (2d Cir. 1971) (citations omitted). Rather, a plaintiff alleging fraud must set forth a factual predicate for the allegations, including specific facts, the sources from which the facts were derived, and "a basis from which an inference of fraud may fairly be drawn." Crystal v. Foy, 562 F. Supp. 422, 424-25 (S.D.N.Y. 1983).

 Plaintiffs have alleged facts which permit the Court to infer fraud in general and scienter in particular. According to plaintiffs, Asch stated that his current intention was to liquidate the shares in PDM, but he did not liquidate. From this, the Court may fairly infer that Asch's statement of current intention was false, that Asch knew it was false, and that he made the false statement with the motive of artificially raising the price of PDM. Plaintiffs claim to have relied on Asch's representation that he would sell the shares of PDM in plaintiffs' accounts, and to have suffered damages as a result. The Court, therefore, cannot dismiss the securities fraud claims, as defendants insist, on the grounds that the Complaint does not allege deceptive or manipulative practices.

 The arguments presented by PAW and Merrill Lynch, in support of summary judgment to dismiss the action, focus on the alleged absence of evidence that they made any material misrepresentation or omission in connection with the purchase or sale of a security which caused damage to plaintiffs or Asch. The gravamen of plaintiffs' Complaint is a failure to sell, while the thrust of Asch's Cross-Claims is that he was unwittingly made a participant in a conspiratorial plan by Merrill Lynch and PAW to artificially manipulate the price of PDM. PAW and Merrill Lynch insist that plaintiffs merely fill the background of their story with incidental episodes of intrigue which they present as evidence of fraudulent intent. Thus, PAW and Merrill Lynch claim that plaintiffs and Asch are unable to state any claims arising under the federal securities laws for which they have offered any supporting evidence.

 The affidavits, exhibits and deposition transcripts submitted by all parties to this litigation raise matters outside the scope of the pleadings. Pursuant to Rule 12(c), Fed. R. Civ. P., the Court will treat all motions as motions for summary judgment. *fn2" For the reasons set forth below, summary judgment is granted in favor of PAW and Merrill Lynch, dismissing the Complaint and cross-motions of plaintiffs and the Cross-Claims of Asch. The Court declines to exercise pendent jurisdiction over the Merrill Lynch Motion for Summary Judgment for Payment of Debit Balances.

 LEGAL DISCUSSION

 Summary judgment shall be granted only if "there is no genuine issue as to any material fact" and the moving party is entitled to judgment as a matter of law. Fed. R. Civ. P. 56(c). On a motion for summary judgment, we are mindful of the maxim that "the court cannot try issues of fact; it can only determine whether there are issues to be tried." Heyman v. Commerce and Indus. Ins. Co. 524 F.2d 1317, 1319-20 (2d Cir. 1975) (citations omitted). Yet, "it must be remembered that the mere existence of factual issues -- where those issues are not material to the claims before the court -- will not suffice to defeat a motion for summary judgment." Quarles v. Gen. Motors Corp., 758 F.2d 839, 840 (2d Cir. 1985). A party "must do more than simply show that there is some metaphysical doubt as to the material facts." Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 106 S. Ct. 1348, 1356, 89 L. Ed. 2d 538 (1986) (citations omitted). While the Court "must resolve all ambiguities and draw all reasonable inferences in favor of the party against whom summary judgment is sought," Heyman, supra, 524 F.2d at 1320 (citation omitted), if the evidence proffered to support plaintiff's theory and to rebut the motion for summary judgment "consists largely of conclusory statements . . . . [s]uch testimony, unsupported by documentary or other concrete evidence . . . is simply not enough to create a genuine issue of fact . . . ." Argus Inc. v. Eastman Kodak Co., 801 F.2d 38, 45 (2d Cir. 1986). "Where the record taken as a whole could not lead a rational trier of fact to find for the non-moving party, there is no 'genuine issue for trial.'" Matsushita, supra, 106 S. Ct. at 1356 (citation omitted).

 Moreover, the Second Circuit Judicial Conference recently concluded that summary judgment dispositions should be made "more readily available in appropriate cases." Second Circuit Committee on the Pretrial Phase of Civil Litigation, Final Report, at 3 (June 11, 1986). See also Knight v. United States Fire Ins. Co., 804 F.2d 9, slip op. at 185-87 (2d Cir. 1986). Having thoroughly reviewed the record, the Court finds that no genuine issue of fact exists with regard to to plaintiffs' ability to state a claim arising under the federal securities laws. Each alleged violation is considered seriatim.

 Section 10(b) and Rule 10b-5

 The essential elements of a § 10(b) or Rule 10b-5 claim for damages are, as follows:

 (1) damage to plaintiff, (2) caused by reliance on defendant's misrepresentations or omissions of material facts, or on a scheme by defendant to defraud, (3) made with an intent to deceive, manipulate or defraud, (4) in connection with the purchase or sale of securities and (5) furthered by defendant's use of the mails or any facility of a national securities exchange.

 Lloyd v. Indus. Bio-Test Laboratories, Inc., 454 F. Supp. 807, 810 (S.D.N.Y. 1978) (citations omitted).

 PAW does not dispute that the allegations of the Complaint and the supporting evidence are sufficient to allow proof of elements (1) and (5) above. PAW concedes that "[t]here may be issues of fact as to whether PAW and Asch acted in accordance with the standards of reasonable conduct in the securities industry." PAW further concedes the possibility that "Asch breached his contract with and duties to plaintiffs by failing to execute orders they allegedly gave him," and further that PAW may be secondarily liable to plaintiffs for Asch's fault. (Memorandum of Law submitted on behalf of PAW, p. 12) ("PAW Memo."). Notwithstanding, PAW contends that the Complaint is insufficient because it makes only conclusory allegations of fraud which do not even relate to the "purchase" or "sale" of a security and thus that there is no genuine issue as to any fact which is material to any claim arising under the federal securities laws.

 In Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 44 L. Ed. 2d 539, 95 S. Ct. 1917 (1975), the Supreme Court recognized the continued vitality of the rule articulated in Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir.), cert. denied, 343 U.S. 956, 96 L. Ed. 1356, 72 S. Ct. 1051 (1952), and held that only those plaintiffs that have actually purchased or sold securities may bring an action under Rule 10b-5. Elaborating on the parameters of this rule, the Supreme Court further held that plaintiffs who allege that they were fraudulently induced not to purchase securities lack standing to sue under Rule 10b-5. "This rule similarly operates to foreclose claims by persons who allege that they were fraudulently induced not to sell securities." Goldman v. A. G. Becker, Inc., [1983 Transfer Binder] Fed. Sec. L. Rep. (CCH) P 99,172 at 95,655 (S.D.N.Y. 1983) (citing Gurley v. Documation Inc., 674 F.2d 253, 256 (4th Cir. 1982)) (emphasis in the original.).

 The Complaint alleges that during the period in 1981 spanning July 23 to August 4, Asch "refused to effectuate and/or sought to discourage direct orders from plaintiffs to sell some or all of their PDM stock." (Complaint, P 25(c)). Asch's Cross-Claims similarly allege, as to Asch's own trading activities, that he was blocked from selling his own shares of PDM (Cross-Claims, PP 45-46), and that he requested sales but was refused. (Cross-Claims, P 54).

 Plaintiffs assert they gave Asch definite orders to sell their shares in PDM, that Asch misled them into thinking that the sales would be carried out; and that they relied on Asch's assurances and suffered damages as a result. Thus, plaintiffs contend that the alleged fraud was "in connection with the sale or purchase" of a security as required by P 10(b) of the Exchange Act. Plaintiffs argue that the concern expressed by the Supreme Court in Blue Chip Stamps, of unlimited potential litigation and speculative claims, is unwarranted in such situations. Their claims are premised on the notion that by giving Asch a definite order to sell, they expressed a more definite and certain intention and desire to act than the potential plaintiffs with which Blue Chip Stamps seemed to be concerned. In essence, the plaintiffs ask this Court to recognize an exception to the rule of Blue Chip Stamps for non-sales or non-purchases resulting from a broker's fraudulent failure to execute a sales order given by a customer.

 Plaintiffs further argue that they meet the purchaser-or-seller test of Blue Chip Stamps, since they eventually sold their shares. Because they are are sellers of securities in the literal sense, plaintiffs maintain that they are entitled to relief if they can show that the alleged frauds were "in connection with" their sales, as required by § 10(b) of the Exchange Act and by Rule 10b-5.

 Plaintiffs rely on cases which have allowed a narrowly construed exception to the Birnbaum rule to permit a Rule 10b-5 suit predicated on a deferred sale. Courts have allowed suits to proceed in such situations "where the plaintiffs signify to the defendant their present intention to sell their shares and are specifically induced thereafter by a fraudulent scheme to retain their shares." Rich v. Touche Ross & Co., 415 F. Supp. 95, 100 (S.D.N.Y. 1976). See also Travis v. Anthes Imperial Ltd., 473 F.2d 515 (8th Cir. 1973); Stockwell v. Reynolds & Co., 252 F. Supp. 215 (S.D.N.Y. 1965). However, this set of facts does not correspond to those alleged by plaintiffs and Asch. They do not claim to have been induced by a fraud to retain their shares, but allege that they consistently attempted to sell them. The claimed deception lies in Asch's allegedly repeated representations that he would, indeed, sell. In light of the Supreme Court's criticism of the "case-by-case erosion" of the Birnbaum rule which would occur if exceptions to it are permitted, Blue Chip Stamps, supra, 421 U.S. at 755, and the Supreme Court's restrictive view of standing to sue under Rule 10b-5, adherence to the exception delineated in Rich v. Touche Ross, supra, is all but extinct. ...


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