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September 15, 1995


The opinion of the court was delivered by: DENNY CHIN


 Plaintiff Gruntal & Co., Inc. ("Gruntal") brings this suit against San Diego Bancorp ("SDBC") and other corporate and individual defendants alleging both federal and common law claims. Gruntal asserts the following claims against all defendants: Violation of section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (hereinafter the "1934 Act"), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder; common law fraud and negligent misrepresentation; and violation of subsections (a), (c) and (d) of section 1962 of the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. § 1962. In addition, Gruntal brings a claim of breach of contract against four of the individual defendants. Defendant George Panagiotou ("Panagiotou") has moved, pursuant to Fed. R. Civ. P. 9(b) and 12(b)(6) and 12(b)(1), to dismiss each of the claims against him.

 Defendants SDBC, James H. Dayley ("Dayley") and Robert B. Crouch ("Crouch") have collectively (though apart from Panagiotou) answered and SDBC has asserted counterclaims against Gruntal and David Gorobetz ("Gorobetz"), *fn1" an attorney employed by Gruntal. SDBC alleges violations of section 10(b) and Rule 10b-5 and RICO section 1962(c). Gruntal and Gorobetz have moved to dismiss the counterclaims pursuant to Fed. R. Civ. P. 9(b) and 12(b)(6).

 For the reasons set forth below, Panagiotou's motion is granted in part and denied in part; and the counterclaims asserted by SDBC are dismissed in their entirety.


 Plaintiff Gruntal, a Delaware corporation with its principal offices in New York, is a securities broker-dealer. Defendant SDBC is organized under the laws of California and operates as an investment company in Los Angeles. SDBC's common shares are traded on the NASDAQ. The individually named defendants are officers of SDBC, private investors, and persons working in various capacities in the securities industry. Corporate defendant Investor Relations, Inc. ("IRI") is owned and controlled by one of the individual defendants, Peter Tosto ("Tosto"). Defendant Panagiotou was at one time an account executive at Dean Witter who was later hired by Gruntal in the same capacity. Plaintiff's complaint alleges that each of the defendants took part in a fraudulent scheme by which they placed orders, or caused others to place orders, to purchase large blocks of SDBC shares. Defendants allegedly had no intention of paying for many of these orders, but instead sought merely to stimulate the market for SDBC in order to profit from selling shares of SDBC on the secondary market.

 The scheme allegedly was conceived by SDBC and one of its investors, Daniel Wirkin ("Wirkin"). SDBC and Wirkin began by approaching SDBC "market makers," *fn3" offering to buy large blocks of SDBC shares. Wirkin eventually accumulated over 125,000 shares from SDBC market makers. With approval of SDBC, Wirkin thereafter enticed others to help with the scheme. These persons included Tosto, and a company Tosto established for this purpose, IRI. *fn4" Together, Wirkin and Tosto/IRI, by means of various enticements such as vacation trips, involved numerous brokers in the scheme. The scheme allegedly targeted young brokers, eager to build client bases. These brokers were provided with "lead cards" and information packages that included a research report prepared by an allegedly fictitious company that was in reality prepared by SDBC and others working at its direction. The brokers were to use the materials to recommend SDBC stock to their existing customers and other brokers. In return, Tosto was to refer new customers to the brokers who would purchase SDBC stock and make other commission-generating transactions.

 One such broker was Panagiotou. Panagiotou allegedly left Dean Witter during the pendency of an investigation of unauthorized trading of SDBC shares for a customer account. After moving to Gruntal, Panagiotou opened one account for IRI and numerous other accounts for individuals referred by Tosto. As part of the scheme to inflate the price of SDBC stock, all of these accounts placed orders for large amounts of SDBC stock through Panagiotou. Many of the orders were never paid for by the customers. Gruntal ultimately was left holding over 100,000 shares of SDBC stock and in the end sold the stock back into the market, incurring losses exceeding $ 450,000. It is alleged that Panagiotou, as part of the scheme, made misrepresentations to Gruntal initially in order to secure employment and later in connection with certain of his customers' accounts, which resulted in Gruntal's losses.


 Gruntal claims that Panagiotou's participation in the scheme violated section 10(b) of the 1934 Act and Rule 10b-5 promulgated thereunder, RICO subsections (a), (c) and (d) of section 1962, and constituted common law fraud and negligent misrepresentation. Defendant Panagiotou has moved to dismiss all of the claims against him, pursuant to Fed. R. Civ. P. 9(b), 12(b)(6) and 12(b)(1).

 1. Section 10(b) and Rule 10b-5 claim

 Section 10(b) prohibits the use of "manipulative or deceptive" practices in connection with the purchase or sale of a security. 1934 Act § 10(b). 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 Basic Inc. v. Levinson, 485 U.S. 224, 231, 99 L. Ed. 2d 194, 108 S. Ct. 978 (1988) (citing Supreme Court decisions re violation elements of section 10(b) and Rule 10b-5 claims); accord In re Time Warner, Inc., Sec. Litig., 9 F.3d 259, 264 (2d Cir. 1993), cert. denied, 114 S. Ct. 1397 (1994).

 a. Fraudulent scheme

 The provisions of Rule 10b-5 are not violated, however, unless the alleged misstatements or omissions are made recklessly or knowingly, i.e., with "'scienter' -- intent to deceive, manipulate, or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193, 47 L. Ed. 2d 668, 96 S. Ct. 1375 (1976) (citation omitted). As a result, the requirements of Fed. R. Civ. P. 9(b) must also be met. Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1127 (2d Cir. 1994).

 Rule 9(b) requires that "the circumstances constituting fraud . . . shall be stated with particularity." Fed. R. Civ. P. 9(b). This requirement ensures that "fraud allegations [will] specify the time, place, speaker and content of the alleged misrepresentations." DiVittorio v. Equidyne Extractive Indus., Inc., 822 F.2d 1242, 1247 (2d Cir. 1987) (citing Luce v. Edelstein, 802 F.2d 49, 54 (2d Cir. 1986)). With respect to scienter, Rule 9(b) provides that allegations of "condition of mind [i.e., scienter,] . . . may be averred generally." While less demanding than the particularity requirement, this part of the rule does not operate as a license for plaintiffs to make conclusory allegations lacking factual foundation. Rather, plaintiffs must "specifically plead those events which give rise to a strong inference of [scienter.]" Connecticut Nat'l Bank v. Fluor, 808 F.2d 957, 962 (2d Cir. 1987) (quoting Ross v. A.H. Robins Co., 607 F.2d 545, 558 (2d Cir. 1979), cert. denied, 446 U.S. 946, 64 L. Ed. 2d 802, 100 S. Ct. 2175 (1980)). The requirements of Rule 9(b) are intended to ensure the defendant has adequate notice of the claim to allow appropriate defense preparation; to protect defendants from calumny-filled complaints; and to reduce "strike suits." See DiVittorio, 822 F.2d at 1247 (citing cases).

 I have no trouble determining that plaintiff's complaint meets the first prong of Rule 9(b)'s requirements. The complaint alleges that Panagiotou affirmatively misrepresented to Gruntal that there were no outstanding and unresolved customer complaints against him. But according to the complaint, unauthorized trades in SDBC shares had resulted in a customer complaint that was allegedly unresolved at the time Panagiotou was hired by Gruntal. Gruntal also alleges that Panagiotou and Tosto misrepresented the net worth, annual income and source of an account opened with Panagiotou in the name of IRI. These allegations specifically identify which representations it claims were false, why it believes they were so, and when the statements were made. The time, place and allegedly false nature of the statements are identified with specificity sufficient to allow Panagiotou to defend against them.

 Accordingly, I turn to the second of Rule 9(b)'s requirements. A plaintiff's complaint may meet the "requisite 'strong inference' of fraud . . . either (a) by alleging facts to show that defendant[] had both motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness." Shields, 25 F.3d at 1128 (citing In re Time Warner, 9 F.3d at 268-69). Plaintiff's complaint is sufficient to meet both of the above requirements.

 First, plaintiff has alleged that, as a young broker, Panagiotou was eager to establish and build a client base and generate commission fees. Panagiotou might well be receptive, therefore, to the schemers' offer to refer customers who would open accounts with him to purchase SDBC shares and make other fee-generating transactions. While a broker at Gruntal, Panagiotou was well positioned to place and execute orders and could recommend SDBC shares to other customers.

 Second, the specific misrepresentations alleged, regarding Panagiotou's separation from Dean Witter and the inaccurately reported financial data of at least one of his customer accounts (IRI), while not necessarily proof of Panagiotou's involvement in the scheme, do provide strong circumstantial evidence of Panagiotou's intent to mislead Gruntal. In addition, the number of accounts opened by Panagiotou, apparently for no purpose other than to place orders for SDBC shares, combined with the subsequent large incidence of non-payment for those orders, quite naturally supports an inference of Panagiotou's involvement in the scheme at some level. *fn5" ...

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