sold all of its shares in one or more large blocks at the bid price, thereby depressing the market for the stock.
SDBC alleges that during this time it had a registration statement in effect and was regularly engaged in the offering and selling of its securities through public offerings and private placements. In addition, SDBC allegedly disclosed to the public, through Securities and Exchange Commission ("SEC") filings, that it was "regularly engaged in efforts to raise additional capital." (Am. Ans., P 45).
Because these filings are a matter of public record, SDBC charges Gruntal with knowledge of their contents, and thus imputes to Gruntal a fraudulent scheme to sell its SDBC holdings in order to undermine their efforts to raise additional capital.
SDBC alleges several theories in support of its claim that the above acts are violative of section 10(b) and Rule 10b-5. In addition, SDBC claims that Gruntal's demand of a 60% premium was extortionate, and that together with numerous unspecified mailings and telephone calls in furtherance of its fraudulent scheme, their conduct formed a pattern of racketeering activity, in violation of RICO section 1962(c).
1. Section 10(b) and Rule 10b-5 Claims
As more fully set out in part I of this opinion a plaintiff claiming violation of section 10(b) and Rule 10b-5 must allege a material misstatement, or an omission rendering statements misleading, made recklessly or knowingly by the defendant, relied upon by the plaintiff in connection with the purchase or sale of a security, and which caused the plaintiff injury. See In re Time Warner, 9 F.3d at 264. SDBC asserts four separate counterclaims that allege violation of section 10(b) and Rule 10b-5. Although the counterclaims are asserted under several different theories, because I conclude that SDBC has failed to plead elements necessary under any section 10(b) claim, each of these counterclaims is dismissed.
a. Market Manipulation Theory
The crux of SDBC's first counterclaim is that Gruntal manipulated the market for SDBC stock by intentionally accumulating the stock in order to depress the share price. Even if this is true, under the facts as alleged it is not conduct proscribed by section 10(b) or Rule 10b-5. "'Manipulation' is 'virtually a term of art when used in connection with securities markets.' . . . The term refers generally to practices . . . that are intended to mislead investors by artificially affecting market activity." Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 476-77, 51 L. Ed. 2d 480, 97 S. Ct. 1292 (1977) (quoting Ernst & Ernst v. Hochfelder, 425 U.S. 185, 199, 47 L. Ed. 2d 668, 96 S. Ct. 1375 (1976)). Artificially affecting the marketplace necessarily implies the existence of information that, if generally known, would change investors' assessment and thus the price of the stock. In the present case, SDBC has not alleged that Gruntal misrepresented or failed to disclose a single material fact in connection with Gruntal's sale of SDBC shares. I agree that Gruntal must have known that the sale of nearly 10% of SDBC's freely tradeable shares might well depress the market price of the stock. But section 10(b) was designed to protect investors from manipulative and deceptive conduct, not to protect share prices from the adverse consequences of large block sales. SDBC is correct that section 10(b) covers "a full range of ingenious devices that might be used to manipulate securities prices," Santa Fe, 430 U.S. at 477, but while the section "is aptly described as a catchall provision, . . . what it catches must be fraud." Chiarella v. United States, 445 U.S. 222, 234-35, 63 L. Ed. 2d 348, 100 S. Ct. 1108 (1980).
b. Shingle Theory
The second, third and fourth counterclaims are predicated upon the so-called "shingle theory."
The broadest enunciation of this theory is that a brokerage firm makes an implied warranty "to the general public . . . that it will deal fairly, reasonably and with integrity in its conduct as a broker-dealer."
(CC Mem. at 17).
SDBC claims that Gruntal misrepresented that it would abide by all applicable industry rules and regulations by failing to sell its SDBC shares promptly as required by Regulation T. It is also alleged that Gruntal's sale of its SDBC holdings at one time was contrary to its implied public representation to deal fairly with the public and obtain the best possible price for securities sold for its customers. SDBC's theory is that Gruntal's actions breached their implied representations to the public and were therefore misrepresentations or omissions in violation of section 10(b) and Rule 10b-5. Assuming, for the sake of argument, the actionability of such breaches, SDBC has failed to demonstrate any causal link between Gruntal's acts and SDBC's loss so as to make them actionable under section 10(b).
"Reliance provides the requisite causal connection between a defendant's misrepresentation and a plaintiff's injury." Basic Inc., 485 U.S. at 243 (Second Circuit citations omitted). As explained in part I of this decision, the reliance element of a section 10(b) claim requires the claimant to plead sufficient facts from which to find both transaction and loss causation. Transaction causation requires that a claimant demonstrate that but for the defendant's representation, claimant would not have entered into the transaction that ultimately caused claimant's loss. See Weiss, 966 F.2d at 111 (citations omitted). Here, even if Gruntal did violate Regulation T,
Gruntal's intention to liquidate its shares at one time was fully disclosed to SDBC before it did so.
Similarly, there is no causal connection between SDBC's losses and Gruntal's obligation to obtain the best price when liquidating defaulted customer accounts. Assuming, for present purposes, Gruntal's breach of such a duty,
the duty exists only between Gruntal and the customers whose positions are liquidated. Gruntal no doubt has a duty to make reasonable efforts to obtain the best price for the shares being liquidated. But that duty does not extend to the issuer of those securities by reason of their coincidental involvement in the liquidation. No representation was made by Gruntal to SDBC with respect to the liquidation of customer positions. SDBC could not have relied, therefore, on Gruntal's implied representation regarding the liquidation of any of its unsettled customer positions.
Finally, SDBC alleges that Gruntal impliedly warranted to the market place and to the public generally that it would obtain the best price possible for liquidated shares, and would deal fairly with the public in the conduct of its business. Again, I need not decide if such implicit duties exist or, assuming they do, whether their breach would be actionable misrepresentations or omissions for purposes of section 10(b) and Rule 10b-5. As noted above, Gruntal's liquidation of SDBC shares provides the only causal link between Gruntal and SDBC's alleged losses. But Gruntal's intention to liquidate its SDBC shares was fully disclosed to SDBC prior to the actual liquidation of those shares. Thus, if Gruntal had an obligation to disclose its intentions to SDBC, it did so prior to any actions taken by SDBC. And, for obvious reasons, SDBC would not have relied on Gruntal's representation, that it would liquidate its shares at one time, in deciding to continue to issue more shares.
Regardless of SDBC's characterization of Gruntal's disclosure as extortionate,
SDBC knew Gruntal planned to sell its SDBC shares as a block if SDBC did not meet its demand of a 60% premium. Gruntal withheld none of its plans. "Once full and fair disclosure has occurred, the fairness of the terms of the transaction is at most a tangential concern of the statute." Santa Fe, 430 U.S. at 477 (citing Mills v. Electric Auto-Lite Co., 396 U.S. 375, 381-85, 24 L. Ed. 2d 593, 90 S. Ct. 616 (1970)).
2. RICO Claim
Reliance is, of course, an indispensable element of any claim of fraud. Having determined that SDBC has failed to demonstrate reliance on any representation or omission by Gruntal, I necessarily conclude that SDBC has failed to allege any cognizable acts of mail and wire fraud.
Accordingly, SDBC has failed to allege sufficient predicate acts to meet the pattern requirement of the statute. See 18 U.S.C. § 1961(5) (pattern requires at least two predicate acts of racketeering activity); H.J. Inc., 492 U.S. at 237-43 (same). SDBC's Rico claim is also dismissed.
Defendant Panagiotou's motion to dismiss Gruntal's section 10(b), common law fraud and negligent misrepresentation claims is denied. Panagiotou's motion to dismiss Gruntal's section 1962(a), (c) and (d) RICO claims is granted. Gruntal is given leave to amend the deficiencies of its complaint within 20 days hereof.
Gruntal's motion to dismiss SDBC's counterclaims is granted in its entirety. SDBC is given leave to amend the deficiencies as noted within 20 days hereof.
Both Gruntal and SDBC are cautioned that although leave to amend has been given, such leave is not a license to rehash otherwise flimsy allegations.
Dated: New York, New York
September 15, 1995
United States District Judge