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November 13, 1991


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

Defendant Michael Milken moves under Rules 12(b) and 9(b), Fed.R.Civ.P., to dismiss all claims against him in this securities fraud class action suit, and under Rule 12(f) to strike portions of the complaint.*fn1

For the reasons discussed below, the motion to dismiss and the motion to strike are granted.


Plaintiffs are shareholders who bought stock in the now-bankrupt First Capital Holdings Corp. ("First Capital") between March 31, 1989 and May 31, 1991.

Their complaint alleges: 1) that Milken either caused or helped defendant Robert Weingarten to establish First Capital, a financial services and insurance holding company that derived much of its revenue from its investment portfolio; 2) that Milken, in his capacity as "junk bond chief" (Morse's term) of the brokerage firm Drexel Burnham Lambert, underwrote First Capital's financing through offerings of junk bonds; 3) that "Drexel/Milken" exercised control over First Capital's investment portfolio and caused it to invest heavily in junk bonds issued by other clients of Milken and Drexel; 4) that First Capital issued statements, including annual reports and reports filed with the Securities and Exchange Commission (SEC), which contained misrepresentations or misleading omissions indicating that its financial condition was sound and that its effective portfolio management reduced the risk normally associated with junk bonds despite the fact that the value of its junk bond portfolio was deteriorating rapidly; 5) that defendants knew or were recklessly indifferent to the falseness of their representations or the misleading nature of their omissions; 6) that plaintiffs bought stock from March 31, 1989 through May 31, 1991 in reliance on those misrepresentations or misleading omissions; and 7) that First Capital collapsed, filing for bankruptcy on May 30, 1991*fn2 and thereby injuring plaintiffs.

Morse alleges that Milken's participation in these events was part of a broader attempt by him to operate a scheme, which Morse calls a "Daisy Chain," by which Milken would both arrange financing for various entities with high-risk, high yield "junk bonds" and cause the same entities to invest in junk bonds of other Milken clients, all in an attempt to create an artificially inflated market for financial products created by Drexel and Milken.

As part of the alleged scheme, Morse claims, Drexel and Milken knowingly "made materially false and misleading statements . . . to prospective purchasers or sellers in order to induce the purchase or sale of high-yield securities," Compl. at ¶ 61, and induced sales of high-yield securities by advising "certain prospective purchasers and sellers that their participation in the Drexel Daisy Chain would increase the price of high-yield securities." Compl. at ¶ 62. The complaint also alleges that Drexel and Milken "purchased and sold high-yield securities while in possession of material information, not generally available to the public, obtained from their relationships with the issuers and purchasers. . . ." Compl. at ¶ 63.

Finally, Morse asserts:

  Milken played an ongoing dominant role in the
  operation of the Daisy Chain. Pursuant thereto, he
  materially aided and abetted the other defendants
  in the wrongdoing herein alleged. Drexel/Milken
  further exercised substantial discretion and
  investment authority over [First Capital's] junk
  securities portfolio which he exercised without
  regard to [First Capital's] stated investment

  and further engaged in numerous unsuitable and
  unnecessary transactions. Defendants' statements
  to the contrary acted as a fraud upon plaintiff .

Compl. at ¶ 64.


According to Morse, the facts alleged constitute violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) and 78t(a) (1988), Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, and common law fraud and negligent misrepresentation.

Milken argues that the claims against him must be dismissed pursuant to Fed.R.Civ.P. 12(b)(6) for failure to state a claim upon which relief can be granted and pursuant to Fed.R.Civ.P. 9(b) for failure to plead the circumstances constituting fraud with particularity. He also maintains that portions of the complaint should be stricken pursuant to Fed.R.Civ.P. 12(f).

Under Rule 12(b), the required inquiry is simply whether Morse has alleged facts that, if true, would constitute a violation of securities laws or applicable common law. Because Morse alleges fraud, his claims must also comply with Rule 9(b), which provides: "In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other condition of mind of a person may be averred generally." Construing Rule 9(b), the Court of Appeals for this Circuit has recently held that "while Rule 9(b) permits scienter to be demonstrated by inference, this `must not be mistaken for license to base claims of fraud on speculation and conclusory allegations.' An ample factual basis must be supplied to support the charges." O'Brien v. National Property Analysts Partners, 936 F.2d 674, 676 (2d Cir. 1991) (quoting Wexner v. First Manhattan Co., 902 F.2d 169, 172 (2d Cir. 1990)).

A. Section 10(b)

Morse argues that his allegations support recovery against Milken for primary violations of § 10(b), for aiding and abetting primary violations by other defendants, for "control person" liability pursuant to § 20(a), and ...

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