The opinion of the court was delivered by: William C. Conner, District Judge.
Manufacturers Hanover Trust Company ("MHT"), a stock transfer
agent for various publicly traded issuers, seeks to recover
under Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b),
Rule 10b-5 of the Securities Exchange Commission,
17 C.F.R. § 240.10b-5, and a variety of common law theories, losses it
sustained as a result of the defalcations of the assistant
manager of its stock transfer department, Thomas Brancato
For the reasons set forth below defendants' motion is
As a stock transfer agent, MHT is entrusted with the custody
and care of publicly traded stock certificates, in transferable
form, by the owners or depositors of such stock certificates.
(Complaint ¶¶ 20-21, 28). Thomas Brancato was employed by MHT
from 1974 to January, 1989. (Complaint ¶ 33). Brancato
supervised MHT's stock transfer operations and had access to
the books and records regarding those operations, and to the
stock certificates held in safekeeping by MHT. (Complaint ¶
34). MHT alleges that beginning in late 1987 and continuing
through January 1989, Brancato embezzled numerous stock
certificates which had been entrusted to MHT for safekeeping by
MHT's client Depository Trust Company ("DTC"). (Complaint ¶
45). MHT alleges that Brancato effected his scheme by
cancelling stock certificates held in DTC's name and issuing
new certificates at first in the names of his confederate
Randolph Caden ("Caden") and Caden's wife, and later in the
name of Brancato's Mackey Investment Fund ("Mackey"). Caden and
his wife opened a brokerage account at Tucker Anthony in
December 1987 and two accounts at Smith Barney in the fall of
1988. (Complaint ¶¶ 36, 40, 41). In December 1988, Brancato
opened an additional brokerage account at Smith Barney under
the Mackey name. (Complaint ¶ 42). The individual account
executive for all these accounts was Robert Serio, who left
Tucker Anthony and joined Smith Barney in the fall of 1988.
(Complaint ¶ 37-39, 43). Brancato caused the reissued stock
certificates to be delivered to and sold by Serio for the
benefit of the aforementioned accounts. (Complaint ¶ 48-72).
MHT discovered Brancato's defalcations in January 1989, and
settled with DTC, the owner of the stock stolen by Brancato, by
replacing it at a cost in excess of one million dollars. DTC
then assigned to MHT such rights as it has in this matter.
(Complaint ¶¶ 91-93).
In April, 1989, Brancato pleaded guilty to three criminal
counts of an information in United States v. Brancato, 89 Cr.
288 (JMW), in this Court. The offenses to which Brancato
pleaded guilty included (i) theft, embezzlement, or
misapplication of securities entrusted to the custody or care
of a bank by a bank officer; (ii) making false entries in the
books, reports or statements of a bank with intent to injure or
defraud; and (iii) sale of forged securities with intent to
deceive other persons and organizations, all in connection with
the matters described herein. (Complaint ¶ 95).
In May, 1990, Caden pleaded guilty to one count of conspiracy
in violation of 18 U.S.C. § 371, contained in a seventeen-count
indictment in United States v. Caden, 89 Cr. 790 (DNE), also in
this Court. (Complaint ¶ 96).
MHT served its complaint on June 26, 1990 alleging a
conspiracy by all defendants to violate Section 10(b) of the
Exchange Act and Rule 10b-5 of the SEC; violations by Smith
Barney, Tucker Anthony and Serio of New York Stock Exchange
Rule 405, the "Know Your Customer" Rule; and defendants' common
law fraud, aiding and abetting, conversion and negligence.
(Complaint ¶ 16).
Neither Smith Barney nor Serio knew who Brancato was until he
opened the Mackey account in December 1988 shortly before
Brancato's illegal activity was discovered by MHT in January
1989. (Complaint ¶¶ 73-74, 91). MHT does not allege that the
stock certificates delivered by Caden to Serio and Smith Barney
were in any way irregular or that Serio or Smith Barney could
have determined from the face of the certificates that they
were stolen. Similarly, there is no allegation of any specific
misrepresentations or omissions by defendants
Smith Barney, Tucker Anthony and Serio. Rather, MHT contends
that Serio and Smith Barney breached a duty to the "investment
public" by not exercising due diligence to learn essential
facts about the Cadens and Brancato and their securities
transactions as required under the "Know Your Customer Rule,"
New York Stock Exchange Rule 405. (Complaint ¶ 16, 73-77,
97-119). MHT alleges that if Smith Barney and Serio had
exercised due diligence to acquire this information, they would
have discovered that the trades by the Cadens and Brancato were
uncharacteristically large; that the assets of the Cadens and
Brancato were too modest to support a credible belief that the
securities sold in their accounts belonged to them; and that
neither the Cadens nor Brancato had documentation or a
verifiable explanation supporting their claims of rightful
ownership of the securities. (Complaint ¶ 104-109). MHT then
asserts that if defendants had used this knowledge and made the
"appropriate inquiries" to MHT, they would have learned that
the securities were stolen in time to prevent the losses.
In order to prevail on a motion to dismiss, the moving party
must demonstrate "beyond doubt that the [non-moving party] can
prove no set of facts in support of his claim which would
entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46,
78 S.Ct. 99, 101-102, 2 L.Ed.2d 80 (1957); Dahlberg v. Becker,
748 F.2d 85, 88 (2d Cir. 1984), cert. denied, 470 U.S. 1084,
105 S.Ct. 1845, 85 L.Ed.2d 144 (1985). A court must take the
factual allegations of the non-moving party's pleadings as true
and construe them in the light most favorable to that party.
See Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 1686,
40 L.Ed.2d 90 (1974); Dwyer v. Regan, 777 F.2d 825, 828-829 (2d
Cir. 1985), reh'g denied, 793 F.2d 457 (2d Cir. 1986).
The essential elements of a claim under Section 10(b) and
Rule 10b-5 promulgated thereunder are (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 (scienter); (4) in connection with the purchase or sale
of securities; and (5) furthered by defendant's use of the
mails in any facility of a ...