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November 19, 1990


The opinion of the court was delivered by: Mukasey, District Judge.


Plaintiff has sued defendants under Rule 10b-5, 17 C.F.R. § 240.10b-5, § 12(2) of the Securities Act of 1933, 15 U.S.C. § 77l, RICO, 18 U.S.C. § 1962, and state law based on alleged overcharges for commissions on his purchases of over-the-counter stock. Defendants have moved to dismiss, raising a host of issues including the statute of limitations, the reach of § 12(2), failure to plead fraud with particularity and failure otherwise to state a claim. As set forth below, the motion based on the statute of limitations is granted in part and denied in part. The remainder of defendants' motions are denied.

Plaintiff is a professional golfer, who lives half the year in Florida and the other half in Pennsylvania. During the period in contention in this lawsuit, plaintiff maintained individual, pension plan and profit sharing accounts with the securities brokerage firm Steinberg & Lyman, and when Steinberg & Lyman went out of business, defendant Baird, Patrick & Co., Inc. Plaintiff transferred his accounts to Baird, Patrick in order to follow his account executives, the two individual broker defendants, Ray Dirks and Paul Morris, from the defunct Steinberg & Lyman to Baird, Patrick. Plaintiff apparently maintains at least one other investment account, at Shearson Lehman Hutton in Stroudsburg, Pennsylvania. Individual defendant Stuart Patrick is the President of Baird, Patrick.

Both Steinberg & Lyman and Baird, Patrick were marketmakers in certain securities. Over the course of his relationship with these firms, plaintiff was solicited by the brokers Dirks and Morris to purchase penny stocks in which these firms made a market. This case arises from a series of purchases by plaintiff of two such stocks, Paperback Software International Corp. ("PSI") and Hybrilonics, from January 1986 to February 22, 1988.

As a market maker, defendant Baird, Patrick charges clients mark-ups rather than commissions on the purchase or sale of stocks in which defendant makes a market. Plaintiff testified at his deposition, the only discovery that has been conducted as yet, that he was aware that defendant was a market maker, but knew only vaguely what a market maker was. Plaintiff also testified that he never really understood what a mark-up was, and he refers to mark-ups and commissions interchangeably in the transcript of the deposition.

In February 1990, Farley fortuitously read a newspaper article reporting that Baird, Patrick had been sued for charging excessive mark-ups on penny stocks in which it made a market. One of the stocks mentioned was PSI. He then called Richard Sablosky, mentioned in the newspaper article as counsel for the plaintiffs, and asked him to investigate whether plaintiff Farley also had a claim. As a result of that investigation, plaintiff brought this suit, alleging that he was fraudulently charged an excessive mark-up in connection with his purchases of PSI and Hybrilonics stock from 1986 through 1988.

Plaintiff's theory is that, as a marketmaker, defendant Baird, Patrick and its employees were under a special duty not to take advantage of customers and had a duty to disclose an excessive mark-up. These are over-the-counter stocks whose prices are not listed other than through the NASD inter-dealer quotation system, often referred to as the "pink sheets." Plaintiff alleges that defendant Patrick would determine that certain pink sheet stocks should be aggressively marketed to retail clients, and then, knowing that clients cannot readily access current market prices, would determine a retail price without taking into consideration the actual current market price for each of these stocks as reflected in National Quotation Bureau's quotations or the prices paid in transactions between broker-dealers. Patrick allegedly would reward his account executives with above-average selling commissions for the selected stocks.

According to plaintiff, PSI and Hybrilonics were two such stocks. When Dirks and Morris recommended that plaintiff purchase these stocks, they quoted him the Baird, Patrick price without disclosing that it bore no reasonable relation to the true market price for the stock. Plaintiff argues that, having no reason to suspect that his brokers were not quoting him the lowest price obtainable, plaintiff reasonably but mistakenly believed that the price quoted him was fair, causing him to purchase the stocks at an unconscionable price.

Defendant moves to dismiss this action pursuant to Fed.R.Civ.P. 12(b)(6) and 9(b) arguing that plaintiff's Rule 10b-5 claims are time-barred and insufficiently pleaded, that plaintiff's § 12(2) claim is also time-barred and legally insufficient, that plaintiff's RICO claims are insufficiently pleaded and otherwise legally insufficient, and that plaintiff's state law claims should be dismissed for lack of subject matter jurisdiction.


Defendants seek summary judgment on plaintiff's Rule 10b-5 claim on two grounds: (1) that plaintiff's claim is barred by the applicable statute of limitations, and (2) that plaintiff's First Amended Complaint fails to state a claim upon which relief can be granted because it fails to plead fraud with particularity as required by Fed.R.Civ.P. 9(b).

1.  Statute of Limitations

Ceres Partners v. GEL Associates, 918 F.2d 349 (2d Cir. 1990), was decided after this motion became fully submitted. In Ceres Partners, the Second Circuit adopted a new federal statute of limitations for Rule 10b-5 actions. In accord with the Third and Seventh Circuits, the Second Circuit, seeking to create a uniform statute of limitations for Rule 10b-5 cases, chose to adopt for such cases the statute of limitations which expressly governs much of the rest of the 1934 Act: no action shall be maintained to enforce any liability created under § 10(b), unless brought within one year after the discovery of the facts constituting the violation and within three years after such violation. Id., at 364; see In re Data Access Systems Secur. Litigation, 843 F.2d 1537 (3d Cir. 1988) (en banc); Short v. Belleville Shoe Manufacturing Co., 908 F.2d 1385 (7th Cir. 1990) (Easterbrook, J.). Application of this new statute of limitations leads to the same result that would follow in this case if I were to apply New York state law, because under New York's borrowing statute I would be required to apply Data Access. Therefore, no rebriefing is necessary to deal with the Second Circuit's decision in Ceres Partners, New York law having been fully briefed by the parties.

The dates of plaintiff's purchases, as recorded in the trade confirmation slips, are listed below:

Stock                      Sale Date
  1.  PSI                       January 31, 1986
  2.  PSI                       February 26, 1986
  3.  Hybrilonics               April 16, 1987
  4.  Hybrilonics               May 1, 1987
  5.  PSI                       February 9, 1988
  6.  PSI                       February 11, 1988
  7.  PSI                       February 19, 1988
  8.  PSI                       February 22, 1988

Plaintiff filed his original complaint on March 29, 1990. After defendants moved to dismiss the complaint, the court granted plaintiff leave to file an amended complaint. Plaintiff's First Amended Complaint was served on April 30 and May 1, 1990.

The Second Circuit has held that "the statute commences to run when the plaintiff has actual knowledge of the alleged fraud or knowledge of facts which in the exercise of reasonable diligence should have led to actual knowledge." Stull v. Bayard, 561 F.2d 429, 243 (2d Cir. 1977), cert. denied, 434 U.S. 1035, 98 S.Ct. 769, 54 L.Ed.2d 783 (1978). This is an objective standard; the statute begins to run when a person of ordinary intelligence would have suspected that he or she was being defrauded. Goodman v. Shearson, Lehman Bros., Inc., 698 F. Supp. 1078, 1082 (S.D.N.Y. 1988). "`[W]here the circumstances are such as to suggest to a person of ordinary intelligence the probability that he has been defrauded, a duty of inquiry arises, and if he omits that inquiry when it would have developed the truth, and shuts his eyes to the facts which call for investigation, knowledge of the fraud will be imputed to him.'" Armstrong v. McAlpin, 699 F.2d 79, 88 (2d Cir. 1983), citing Higgins v. Crouse, 147 N.Y. 411, 416, 42 N.E. 6 (1895). The parties agree that Data Access has been interpreted to require plaintiffs to satisfy the same standard: "The limitations period in Rule 10b-5 claims begins to run `from the date plaintiff discovered or in the exercise of reasonable diligence should have discovered the facts underlying their claims.'" Procacci v. Drexel Burnham Lambert, Inc., 1989 WL 121984, 1989 U.S. Dist. LEXIS 12208, at p. 6 (E.D.Pa. 1989), quoting ITG, Inc. v. Price Waterhouse, 697 F. Supp. 867, 870 (E.D.Pa. 1988); Bradford-White Corp. v. Ernst & Whinney, 699 F. Supp. 1085 (E.D.Pa. 1988), rev'd on other grounds, 872 F.2d 1153 (3d Cir.), cert. denied Ernst & Whinney v. Bradford-White Corp., ___ U.S. ___, 110 S.Ct. 542, 107 L.Ed.2d 539 (1989); Elysian Federal Savings Bank v. First Interregional Equity Corp., 713 F. Supp. 737, 745 (D.N.J. 1989).

Defendants argue that the price of the securities plaintiff purchased is readily available from other brokerage firms, including plaintiff's Pennsylvania brokerage firm with which plaintiff was in contact on various other matters, and from the National Quotation Bureau. According to defendants, a reasonable investor would have called the National Quotation Bureau or another broker after having been quoted a price for the stock by defendants. A reasonable investor, according to defendants, would therefore have discovered defendants' alleged fraud contemporaneously with the purchases. Under defendants' analysis, all of plaintiff's claims are time-barred as not having been brought within one year of the transactions.

Under Fed.R.Civ.P. 56(c), a trial judge may grant summary judgment only if the evidence demonstrates that "there is no genuine issue as to any material fact and [that] the moving party is entitled to a judgment as a matter of law." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 250, 106 S.Ct. 2505, 2511, 91 L.Ed.2d 202 (1986). In determining whether a genuine issue of material fact has been raised, a court must resolve all ambiguities and all reasonable inferences against the moving party. United States v. Diebold, Inc., 369 U.S. 654, 655, 82 S.Ct. 993, 994, 8 L.Ed.2d 176 (1962) (per curiam), cited in Donahue v. Windsor Locks Bd. of Fire Comm'rs, 834 F.2d 54, 57 (2d Cir. 1987).

I cannot find that, as a matter of law, plaintiff had a duty to suspect that his brokers were not charging him a reasonable price for stocks he purchased on their recommendation. Plaintiff has testified that he relied on the expertise of defendants Morris and Dirks, employees of defendant Baird, Patrick, and based on his deposition testimony as to his longstanding relationship to them, this reliance was not, for purposes of summary judgment, unreasonable. Other courts have found that, for purposes of summary judgment, failure of a broker-dealer to disclose an excessive mark-up could constitute a material omission under Rule 10b-5. See Ettinger v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 835 F.2d 1031 (3d Cir. 1987) ("This fraud is avoided only by charging a price which bears a reasonable relation to the prevailing price or disclosing such information as will permit the customer to make an informed judgment upon whether or not he will complete the transaction."); Elysian Federal Savings Bank v. First Interregional Equity Corp., 713 F. Supp. 737 (D.N.J. 1989); Krome v. Merrill Lynch & Co., Inc., 637 F. Supp. 910 (S.D.N Y 1986). It is implicit in these holdings that a plaintiff may reasonably assume that any materially excessive mark-up will be disclosed by his broker. To impose a duty on the average individual investor to call other brokers or the National Quotation Bureau to double-check prices quoted him by his broker would be to impose a duty beyond reasonable diligence.

The statute began to run not on the dates of the transactions, but rather only when plaintiff was in possession of facts which gave him reason to believe defendants' mark-ups were excessive. According to plaintiff, this did not occur until he fortuitously read a newspaper article about defendants in 1990. Before then, plaintiff argues, he had no reason to suspect fraud. Defendants have pointed to nothing other than the pink sheets plaintiff could have obtained from other brokers or the National Quotation Bureau to prove that plaintiff should have known of the excessive markups prior to the newspaper article. Because plaintiff brought his complaint within one year from the time he alleges he read the newspaper article that gave him reason to suspect fraud, none of plaintiff's claims are barred by the one-year discovery rule of Ceres Partners.

However, there are two prongs to the statute of limitations, both of which plaintiff must avoid in order to maintain an action under Ceres Partners. Ceres Partners holds that a plaintiff must bring a claim for a Rule 10b-5 violation "within three years after such violation." Two of plaintiff's claims allege violations which occurred in 1986, more than three years before plaintiff's Complaint was filed. Plaintiff alleges that defendants fraudulently concealed their actions, thereby tolling the statute of limitations. District courts in the Third Circuit have held that the doctrine of equitable tolling is not available under Data Access. The three-year outside limitation is an absolute limitation. Ferreri v. Mainardi III, 1989 WL 11071, 1989 U.S. Dist. LEXIS 1080 p. 11 (E.D.Pa. 1989); Zimmer v. Gruntal & Co., Inc., 732 F. Supp. 1330 (W.D.Pa. 1989); Cohen v. McAllister, 688 F. Supp. 1040, 1045 (W.D. Pa. 1988). It may be more precise to say that equitable tolling is applicable to these cases, but that it allows plaintiff to extend the statute of limitations only to a maximum of three years. The outer limit of three years is more in the nature of a statute of repose than a statute of limitations. The Seventh Circuit agrees. Belleville Shoe Manufacturing Co., 908 F.2d at 1391.

Plaintiff has not pleaded facts sufficient to establish equitable estoppel, nor has he argued that defendants are equitably estopped to assert the statute of limitations as a defense. There is therefore no reason to discuss whether the Second Circuit would allow equitable estoppel to extend plaintiff's time to file beyond the three-year outside limitation. The Seventh Circuit has held that equitable estoppel cannot be used by plaintiffs to extend the three-year outside limitation. Id. Plaintiff's Rule 10b-5 claims based on the 1986 purchases of PSI stock in any event are time-barred.

Plaintiff's Rule 10b-5 claim based on his April 16, 1987 purchase of Hybrilonics stock is also time-barred. Plaintiff asserted this claim for the first time in the First Amended Complaint, which was served on defendants on April 30, 1990, more than three years from the date of the transaction.

Fed.R.Civ.P. 15(c), governing relation back of amendments, states: "[w]henever the claim or defense asserted in the amended pleading arose out of the conduct, transaction, or occurrence set forth or attempted to be set forth in the original pleading, the amendment relates back to the date of the original pleading." To determine whether new allegations relate back, the court must determine whether the original pleading gave the defendant sufficient notice of them. Schiavone v. ...

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