United States District Court, Southern District of New York
February 23, 1990
GERTRUDE STANDER, PLAINTIFF,
FINANCIAL CLEARING & SERVICES CORPORATION, DOMESTIC ARBITRAGE GROUP, INC., RUSHMORE SECURITIES, JERRY W. CZIN AND JOHN DOES NOS. 1-10, DEFENDANTS.
The opinion of the court was delivered by: Leisure, District Judge.
This is a securities fraud action arising out of defendants'
allegedly improper trading in plaintiff's account. Plaintiff
alleges that as a result of defendants' improper activities,
particularly during the stock market crash of October 1987,
she lost her entire investment and accumulated substantial
trading deficits. Defendant Financial Clearing and Services
Corporation has come to the Court on behalf of itself, and any
of the listed John Doe defendants affiliated with that
company, urging dismissal of the first cause of action in the
complaint against them, pursuant to Fed.R.Civ.P. 12(b)(6).
Plaintiff has cross-moved for an order staying the arbitration
proceeding with defendant Financial Clearing & Services
Plaintiff Gertrude Stander ("Stander") is an elderly widow,
allegedly naive in the ways of securities investing. In early
1987, Stander opened an investment account with defendant
Domestic Arbitrage Group, Inc. ("Domestic"), through defendant
Jerry Czin ("Czin"), a vice-president of Domestic. Stander
allegedly told Czin that she was only interested in
conservative investments that would provide some on-going
income. In March 1987, Stander transferred $80,000 into an
account set up by Czin for investment purposes. A month later,
Domestic advised Stander that all of the trades in her
accounts would be maintained by defendant Financial Clearing
and Services Corporation ("FiCS"). In May 1987, Stander signed
a customer agreement, margin account agreement, and an option
account agreement with FiCS, to allow FiCS to maintain records
on her account and process any trades in that account. FiCS
required Domestic to provide executed copies of these
documents before FiCS would service any account managed by
Stander alleges that over the next five months, FiCS, at the
direction of Czin and Domestic, executed hundreds of risky
options trades in her account. During this period, due to
losses in the option trading ordered by Czin and Domestic,
FiCS made four demands on Stander for additional cash input
into her account to cover margin deficiencies. Stander alleges
that she did not understand those demands when she received
them, and was told by Czin to ignore them when she asked for
information regarding those demands. Stander never made the
cash inputs demanded by FiCS. Nonetheless, FiCS continued to
process trades in Stander's account authorized by Czin.
Losses accumulated in the account almost from the moment
Czin began trading activity. However, the losses were severely
exacerbated by the swift and dramatic downturn in the stock
market in the second week of October 1987. On October 19,
1987, the day the Dow Jones Industrial Index dropped over 500
points, FiCS informed Stander that her account was some
$211,000 in deficit. A week later, FiCS informed Stander that
it had liquidated her account, but that, even after
liquidation, her account showed a deficit of some $274,166.93.
Plaintiff commenced this action on February 3, 1988. On May
24, 1988 the parties agreed to arbitrate all claims except
those arising under the federal securities laws, though FiCS
continued to assert that plaintiff's securities laws claims
were also arbitrable. On August 10, 1989, this Court issued an
opinion and order refusing to compel arbitration of the
securities laws claims, but finding that plaintiff's complaint
failed to allege sufficiently fraud by FiCS, and thus
dismissed the claims against FiCS pursuant to Fed.R.Civ.P.
9(b). Stander v. Financial Clearing & Services Corp.,
718 F. Supp. 1204 (S.D.N.Y. 1989).
FiCS has now returned to the Court, after plaintiff's filing
of an amended complaint, alleging that plaintiff has failed to
state a claim against FiCS for which relief can be granted,
and thus urging dismissal
of the complaint pursuant Fed.R.Civ.P. 12(b)(6). Plaintiff has
cross-moved to stay FiCS' pending arbitration proceeding on
the non-securities law claims arising from this litigation.
A) Defendant FiCS' Motion to Dismiss
A motion to dismiss under Fed.R.Civ.P. 12 must be denied
"unless it appears beyond a doubt that the plaintiff can prove
no set of facts in support of his claim which would entitle
him to relief." Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S.Ct.
1683, 1686, 40 L.Ed.2d 90 (1974), citing Conley v. Gibson,
355 U.S. 41, 45-46, 78 S.Ct. 99, 101-102, 2 L.Ed.2d 80 (1957);
Morales v. New York State Dep't of Corrections, 842 F.2d 27, 30
(2d Cir. 1988). The Court must accept plaintiff's allegations
of facts as true together with such reasonable inferences as
may be drawn in her favor. Murray v. City of Milford,
Connecticut, 380 F.2d 468, 470 (2d Cir. 1967). See also
Scheuer, supra, 416 U.S. at 236, 94 S.Ct. at 1686, Fed.R.Civ.P.
8 requires only a "'short and plain statement of the claim'
that will give the defendant fair notice of what the
plaintiff's claim is and the ground upon which it rests."
Conley, supra, 355 U.S. at 47, 78 S.Ct. at 102 (cited in Hishon
v. King & Spaulding, 467 U.S. 69, 73, 104 S.Ct. 2229, 2232, 81
L.Ed.2d 59 (1984)). For the purposes of a Rule 12 motion, "The
pleading is deemed to include any document attached to it as an
exhibit, Fed.R. Civ.P. 10(c), or any document included in it by
reference." Goldman v. Belden, 754 F.2d 1059, 1065-66 (2d Cir.
1985) (citations omitted).
"The function of a motion to dismiss 'is merely to assess
the legal feasibility of the complaint, not to assay the
weight of the evidence which might be offered in support
thereof.'" Ryder Energy Distribution Corp. v. Merrill Lynch
Commodities, Inc., 748 F.2d 774, 779 (2d Cir. 1984) (citations
omitted). "Dismissal of a complaint for failure to state a
claim is a 'drastic step.'" Meyer v. Oppenheimer Management
Corp., 764 F.2d 76, 80 (2d Cir. 1985) (citations omitted).
FiCS is a clearing broker. Its duties are to provide
record-keeping functions for the accounts it handles, and, in
some cases, to accomplish the actual settlement of trades for
those accounts. Lester v. Basner, 676 F. Supp. 481, 482
(S.D.N.Y. 1987). The clearing broker normally has no direct
contact with the individual customer, except for mailing copies
of reports and records regarding the account to the customer on
a regular basis. Trades are ordered through or by the retail
broker, who has personal contact with the customer. Such was
the situation in the instant case. There is no allegation that
FiCS or its employees ever had direct contact with Stander.
Stander did sign a customer and other agreements with FiCS, but
this was done through the auspices of Domestic. FiCS' only
contact in the transactions at issue was with Domestic and
Czin, who ordered the allegedly improper trades.
Plaintiff alleges that FiCS aided and abetted Domestic's and
Czin's securities law violations. A number of courts have
addressed the issue of the liability of a clearing broker as
an aider and abetter of securities fraud in violation of
section 10(b) of the Securities Exchange Act of 1934,
15 U.S.C. § 78j. The Second Circuit has held that in order to make
out a claim for aiding and abetting a substantive securities
offense, a plaintiff must allege, "(1) the existence of a
securities law violation by the primary (as opposed to the
aiding and abetting) party; (2) 'knowledge' of this violation
on the part of the aider and abettor; and (3) 'substantial
assistance' by the aider and abettor in the achievement of the
primary violation." Bloor v. Carro, Spanbock, Londin, Rodman &
Fass, 754 F.2d 57, 62 (2d Cir. 1985), citing IIT v. Cornfeld,
619 F.2d 909, 922 (2d Cir. 1980). Viewing the pleadings in the
light most favorable to plaintiff, as the Court must for this
motion, the Court will accept the uncontested assertion that
sufficient facts have been alleged to meet the first
requirement for aiding and abetting liability.
The Court, then, must focus on whether plaintiff has
sufficiently alleged that FiCS had knowledge of Domestic's and
Czin's securities law violations, and that FiCS provided
substantial assistance to Domestic and Czin in their
achievement of the violation. It is clear that the simple
providing of normal clearing services to a primary broker who
is acting in violation of the law does not make out a case of
aiding and abetting against the clearing broker. Baum v.
Phillips, Appel & Walden, Inc., 648 F. Supp. 1518 (S.D.N Y
1986), aff'd, 867 F.2d 776 (2d Cir.), cert. denied, ___ U.S.
___, 110 S.Ct. 114, 107 L.Ed.2d 75 (1989). Plaintiff must
allege that the clearing broker had knowledge of the primary
broker's fraudulent activity and gave substantial, knowing
assistance to that illegal activity.
Before the Court can determine whether FiCS had knowledge of
the securities law violation alleged, it is necessary to
examine just what that alleged violation is. Plaintiff asserts
that Domestic and Czin misled Stander as to their intent with
regard to her account, misled her as to the meaning of the
agreements she signed with FiCS, and then manipulated her
account in a way designed to maximize Domestic's and Czin's
profits, while continuing to mislead Stander as to the status
of her account. Plaintiff appears to allege that FiCS, through
its clearing activities knew, or should have known, that
Domestic and Czin were engaged in illegal activity.
"[A] clearing agent  is generally under no fiduciary duty
to the owners of securities that pass through its hands."
Edwards & Hanly v. Wells Fargo Securities Clearance Corp.,
602 F.2d 478, 484 (2d Cir. 1979), cert. denied, 444 U.S. 1045, 100
S.Ct. 734, 62 L.Ed.2d 731 (1980), citing Woodward v. Metro Bank
of Dallas, 522 F.2d 84, 97 & n. 29 (5th Cir. 1975). Where there
is no fiduciary duty, plaintiff must allege actual knowledge of
the fraudulent activity on the part of the aider and abettor.
"We have not used the 'recklessness' standard when money
damages are claimed in an aiding and abetting context, except
on the basis of a breach of fiduciary duty." Edwards & Hanly,
supra, 602 F.2d at 484.
Plaintiff has alleged that FiCS knew that the other
defendants were ordering frequent trades in Stander's accounts
that were quite risky, that the trading continued despite
unsatisfied margin calls, and that FiCS knew that Stander was
an elderly person who initially had conservative investment
intentions.*fn2 Even assuming that FiCS knew of Stander's age
and intentions, the Court cannot find that plaintiff has
sufficiently alleged actual knowledge of the securities law
violation. First, plaintiff had executed at least two
documents authorizing Czin as her agent for trading. Amended
Complaint ¶¶ 13, 16. Plaintiff does not allege that FiCS knew
or should have known that those authorizations were improper.
The trading in plaintiff's account was, at all times, conducted
by Czin pursuant to those authorizations. FiCS' only contact
with the activity of the account was through Czin. Plaintiff
does not allege that she directly instructed FiCS to take any
action regarding her account. Plaintiff alleges that FiCS knew
or should have known that the trading authorized by Czin was
improper because of FiCS' alleged knowledge of plaintiff's
stated investment objectives. Assuming FiCS was so aware of
plaintiff's original intention, FiCS was also faced with a
clear authorization for Czin to act as plaintiff's agent on the
account. Since there is no allegation that
FiCS knew that authorization to be fraudulent or improper,
there can be no finding that plaintiff has sufficiently
alleged that FiCS actually knew that the trades executed at
Czin's instruction were improper.
Plaintiff asserts that even if FiCS did not have actual
knowledge of Czin's fraudulent activity in regard to Stander's
account, FiCS should be held to a recklessness standard in
regard to its knowledge of Czin's activity because FiCS did in
fact have a fiduciary duty to plaintiff under New York Stock
Exchange Rule 405. It is clear, however, that the duties
imposed under Rule 405 may be divided between the introducing
broker and the clearing broker. New York Stock Exchange Rule
382. Domestic and FiCS executed a clearing agreement that so
divided such duties. Section 4.2 of that agreement makes
Domestic responsible for assuring that all activity under the
agreement comports with applicable rules. Fully Disclosed
Clearing Agreement, attached as Exhibit B to Plaintiff's
Memorandum of Law. Accordingly, the Court cannot find that
Rule 405 imposes any fiduciary duty upon FiCS under the
circumstances of this case.
Finally, plaintiff argues that FiCS had a duty of inquiry to
Stander because FiCS knew that Domestic and Czin were acting
as Stander's agent. As noted above, however, Stander had
executed two documents giving Czin full authority over trading
in her account. Plaintiff has not alleged that FiCS knew or
should have known that those authorizations were improper.
Thus, there was no reason for FiCS to question the scope of
Czin's activities. Czin was acting under actual authority
granted him by Stander. The Court thus cannot find that FiCS
had any obligation to examine Czin's activities.*fn3
Accordingly, the Court cannot find actual knowledge on the
part of FiCS, nor can it find a fiduciary duty on the part of
FiCS that would require greater inquiry.*fn4
Plaintiff also fails to allege sufficient facts to support
a claim that FiCS substantially assisted in Domestic's and
Czin's fraudulent activity. Plaintiff alleges that FiCS aided
the fraudulent activity by continuing to execute and record
trades in Stander's account despite Stander's failure to meet
margin calls, and despite FiCS' alleged knowledge of Stander's
initial conservative investment goals. A simple allegation of
inaction can make out a claim of aider and abettor liability
"only where there is a conscious or reckless violation of an
independent duty to act." IIT, supra, 619 F.2d at 927. As noted
above, the only duty the Court finds FiCS had to Stander was a
duty to report on the activity of her account. That FiCS did
faithfully. It would be an unfortunate stretch of liability to
hold that a clearing broker, whose only privity-created
obligation to an investor is a reporting one, must undertake
the obligation of insuring that the investor, who has signed
customer agreements outlining the broker's responsibilities,
fully understand the reports provided, and that the investor
acts on them in the most prudent manner. Such would be taking
paternalism to an extreme.
Plaintiff does not allege that FiCS aided Domestic and Czin
in their misrepresentations. She does not allege that FiCS
encouraged Czin's churning of her accounts.
She alleges that FiCS did not act to stop Czin's acitivities
which were facially authorized by two documents signed by
Stander at different times. Plaintiff also alleges that FiCS
took profits from the trade authorized by Czin. In essence,
then, Stander argues that by clearing and servicing her
account in the manner agreed to both by Domestic and Stander,
FiCS substantially assisted in Domestic and Czin's illegal
activity. The Court has already noted that a clearing broker
cannot be held liable as an aider and abettor simply because
it performed its contracted-for services. Baum, supra.
Plaintiff has alleged that by performing its contracted-for
services, clearing trades in plaintiff's account and reporting
on those transactions, FiCS was an aider and abettor to
Domestic and Czin's activities. Absent some fiduciary duty of
FiCS to plaintiff, which has not been alleged in the amended
complaint, such inaction does not make out a claim for aiding
and abetting. Accordingly, plaintiff's claim of aiding and
abetting a securities law violation against FiCS must be
B) Plaintiff's Motion to Stay FICS' Arbitration
Plaintiff has moved to have this Court impose a stay on
arbitration proceedings either already begun or imminent on
plaintiff's non-securities law claims against FiCS. Further,
plaintiff requests the Court to order expedited discovery on
the matters still before the Court and also set an early trial
date on those issues. The Court denies each of these
The Congress and federal courts have expressed a strong
policy favoring arbitration. "'[The Federal Arbitration Act,
9 U.S.C. § 1, et seq.] leaves no place for the exercise of
discretion by a district court, but instead mandates that
district courts shall direct the parties to proceed to
arbitration on issues as to which an arbitration agreement has
been signed.'" Genesco, Inc. v. T. Kakiuchi & Co., Ltd.,
815 F.2d 840, 844 (2d Cir. 1987), quoting Dean Witter Reynolds Inc.
v. Byrd, 470 U.S. 213, 218, 105 S.Ct. 1238, 1241, 84 L.Ed.2d
158 (1985) (emphasis in original). "A party must demonstrate
prejudice before it can defeat efforts to resolve a dispute
through arbitration." Graphic Scanning Corp. v. Yampol,
850 F.2d 131, 133 (2d Cir. 1988).
Plaintiff has entered into agreement with Czin and Domestic,
staying arbitration with those parties, pending resolution of
the matters now before this Court involving those parties.
Plaintiff claims that FiCS' failure to enter into a similar
agreement, and its subsequent decision to pursue immediate
arbitration of those claims not before this Court results in
a prejudice to her claims. Plaintiff provides no legal basis
on which the Court may act to stay the pending arbitration,
other than an implicit assertion of this Court's equitable
The Court declines to so exercise its powers. First, the
Court's dismissal of the securities law claims against FiCS
reduces any potential prejudice arising from parallel,
simultaneous proceedings. After this opinion and order, all of
plaintiff's remaining claims against FiCS will be before the
arbitrator. Second, to the extent that plaintiff's arbitration
with FiCS may be affected by the decision to stay her
arbitration with Domestic and Czin, the Court cannot find that
it should shift the burden to FiCS simply because plaintiff
chose a certain litigation route with other parties through an
agreement to which FiCS was not a party. Finally, the Court
takes seriously, as it must, the federal policy in favor of
arbitration, and will not interfere with an arbitration
proceeding, absent a showing of a pressing need for Court
intervention. Thus, the Court will not order a stay of the
arbitration between plaintiff and FiCS.
Similarly, the Court will not order an expedited discovery
schedule and early trial for this matter. Plaintiff was
offered the opportunity to arbitrate all her claims and chose,
instead, to oppose arbitration of some of her claims. As
plaintiff's counsel well knows, the choice of litigating
certain claims, while it offers certain advantages, also comes
with certain costs, which include the conducting of discovery
in a regular and thorough manner. This case is in the capable
hands of United States Magistrate
Barbara Lee for supervision of discovery. The Court will not
interfere with the discovery schedule set by the Magistrate.
If plaintiff wishes an adjustment of the discovery schedule,
she should take that issue to the Magistrate.
Defendant FiCS' motion to dismiss Count One of the Amended
Complaint against it is granted.
Plaintiff's cross-motion to stay arbitration and for
expedited proceedings is denied.
The reference of this matter to United States Magistrate
Barbara Lee for general pre-trial supervision is renewed.