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September 26, 1995



The opinion of the court was delivered by: SWEET


Sweet, D.J.

 In this action, the complaint of plaintiff Kidder Peabody & Co., Inc. ("Kidder"), seeks damages for breach of contract, and Defendant Unigestion International, Ltd. ("Unigestion") has counterclaimed for: (i) fraud; and (ii) violations of § 12(2) of the Securities Act of 1933 (the "Securities Act"); (iii) Section 15(c)(3) of the Securities Exchange Act of 1934 (the "Exchange Act") and rule 15c3-3(b)(4)(i) promulgated under the Exchange Act; (iv) Section 15C(b)(7) of the Exchange Act and Regulation 403.4 promulgated under the Exchange Act and has interposed affirmative defenses on the grounds that third-party defendants Askin Capital Management, L.P. ("ACM"), David J. Askin ("Askin") and Dashstar Corporation ("Dashstar") were not authorized to transact business with Kidder on Unigestion's behalf and on grounds of fraud. Kidder moves pursuant to Rule 9(b), Fed. R. Civ. P., to dismiss Unigestion's fraud counterclaims and defenses for failure to plead fraud with particularity. Kidder has moved pursuant to Rules 12(c) and 12(f), Fed. R. Civ. P., for judgment on the pleadings with regard to Unigestion's Exchange Act counterclaims and defenses based on lack of authorization.

 Unigestion cross-moved for leave to amend its counterclaims. At oral argument of the instant motions on June 21, 1994, Unigestion's Answer was deemed amended, as described further, infra.

 For the reasons below set out below, Kidder's motion is granted in part and denied part.

 The Parties

 Kidder is a Delaware corporation with its principal offices in New York City. Kidder is a broker-dealer registered pursuant to Sections 15 and 15C of the Exchange Act, 15 U.S.C. §§ 78o and 78o-5. Unigestion is a foreign corporation having its principal place of business in Guernsey, Channel Islands, United Kingdom.

 Relevant Non-Parties

 ACM is a registered investment adviser. Dashstar is ACM's general partner. Askin is Dashstar's chief executive officer. (ACM, Dashstar and Askin are collectively referred to herein as "Askin/ACM"). Granite Partners L.P. ("Granite Partners"), registered in the State of Delaware, Granite Corporation, incorporated in the Cayman Islands ("Granite Corporation"), and Quartz Hedge Fund ("Quartz"), incorporated in the Cayman Islands, are investment funds established and managed by Askin (collectively, the "Askin Funds"). ACM is the investment adviser of the Askin Funds.

 Prior Proceedings

 Kidder commenced this action by filing its Verified Complaint in New York State Supreme Court for New York County on April 14, 1994. The case was removed to the Southern District of New York on May 4, 1994, and assigned to this Court based on its relation to UBS Securities, Inc. v. Unigestion Int'l, Ltd., 94 Civ. 3238; Arbour Financial Corp. v. Unigestion Int'l, Ltd., 94 Civ. 3239; Lehman Government Securities, Inc. v. Unigestion Int'l, Ltd., 94 Civ. 3240; and Bear Stearns & Co., Inc. v. Unigestion Int'l, Ltd., 94 Civ. 4444. Unigestion filed its Answer and Counterclaims on June 17, 1994, and lodged a third-party complaint against ACM, Dashstar, and Askin on June 30, 1994. Kidder filed its Reply to Unigestion's counterclaims on July 21, 1994.

 Discovery and discovery-related motion practice was conducted throughout the latter half of 1994 and early 1995. Kidder filed its motion to dismiss Unigestion's counterclaims for failure to plead fraud with particularity and for partial judgment on the pleadings on November 23, 1994. Unigestion filed its motion to amend its counterclaims on January 18, 1995. The parties consented to the rescheduling of these two motions so that they could be argued at the same time. The return date for these motions was subsequently adjourned on consent on three occasions. Oral argument was heard on June 21, 1995, the motions were deemed fully submitted at that time, and Unigestion's Answer, including Counterclaims (hereinafter the "Amended Answer" and the "Amended Counterclaims") was deemed so amended.

 The Factual Allegations *fn1"

 The dispute underlying this action grows out of the collapse, in February and March of 1994, of the specialized market in collateralized mortgage-backed securities and related derivatives ("CMOs"). Unigestion is a foreign investment corporation. ACM is a registered investment adviser. Askin is its president. Kidder is one of five broker-dealers who were active in the CMO market and with whom ACM entered into contracts and conducted trades on Unigestion's behalf.

 The Askin/Unigestion Relationship

 Unigestion contacted ACM/Askin in 1993. During the first half of 1993, Askin and other ACM personnel made verbal and written representations that they were "Mortgage Derivative Security Specialists" and that ACM had developed a "market neutral" investment strategy for investment in various mortgage derivative securities which could be used to protect the value of an investment portfolio against price fluctuations in financial markets. ACM/Askin described this strategy as nonspeculative and involving "little risk." ACM/Askin represented that through the use of its own computer-analytical models and hedging techniques, it could select a portfolio of "bullish" (inversely responsive to interest rates) and "bearish" (directly responsive to interest rates) securities. ACM/Askin represented to Unigestion that such a portfolio could be balanced to create an investment whose performance would be "market neutral". ACM/Askin also represented that they were able to identify "mispriced" securities and to capitalize on this informational advantage. ACM/Askin further represented to Unigestion that the average yearly return from the Ask in Funds had been over 15% for at least the previous three years. ACM/Askin compared that annual rate of return with other, lower-yielding investment instruments but did not disclose that the lower-yielding instruments were safer investments. Finally, ACM/Askin represented that the proposed portfolio would contain investments that were limited to terms of one year, thus further reducing the risk associated with interest rate volatility. The portfolio ultimately assembled on behalf of Unigestion had a duration of more than one year and was correspondingly more risky than had been originally represented.

 The Investment Management Agreement

 On February 1, 1994, an Investment Management Agreement ("IMA") was executed by ACM and Unigestion, providing that ACM was to be Unigestion's investment advisor with respect to certain funds to be deposited in a custodial account at State Street Bank & Trust Co. ("State Street"). On February 2, 1994, Unigestion opened the custodian account at State Street; number 5450 (the "Account"). Unigestion deposited $ 10,000,000 in the Account on February 2, 1994, which was to be invested in accordance with the IMA. Under the IMA, Unigestion gave ACM the responsibility of managing the funds in the Account.

 The Account was created pursuant to an agreement between Unigestion and State Street (the "Custodian Agreement"). ACM/Askin are not parties to the Custodian Agreement. By the Custodian Agreement, Unigestion employed State Street as custodian of "certain assets of [Unigestion] and assets beneficially owned by certain customers of [Unigestion]" and defined these assets as the "Account". No other meaning or description appeared in the Custodian Agreement concerning the "Account".

 The Custodian Agreement also named ACM as "Investment Manager" and required the Custodian to accept any instruction from ACM as if an instruction of Unigestion, so long as such instructions conformed to the provisions of the Custodian Agreement's section of "Proper Instructions". That section set out the acceptable communications media by which instructions might be conveyed and required that such instructions be accepted by State Street only if they came from authorized representatives of ACM or Unigestion. The Custodian Agreement also set out the requirements under which State Street was permitted to pay out account moneys.

 Officers of Unigestion signed all documents relating to the opening of the Account. The IMA provided that ACM would invest Unigestion's funds in accordance with the investment strategy that was outlined in the Investment Guideline (the "Guideline") which was an exhibit to the IMA and was incorporated by reference therein. The Guideline stated that the objective of the investment program that ACM was to undertake for Unigestion was "to generate monthly results largely free of correlation with equity and fixed income market monthly returns." In meetings and in documents described above, ACM represented that this strategy was "market neutral," like that employed for Granite Partners and Granite Corporation--investment vehicles with which Unigestion personnel were familiar.

 By its incorporation of the Guideline, the IMA required that Unigestion's portfolio would "be broadly diversified by security type." One family of instruments, inverse floating rate interest only securities ("Inverse IOs"), comprised 56% of the portfolio that ACM assembled for Unigestion. The Guideline contains a non-exclusive list of instruments to be used in assembling the portfolio. Inverse IOs are not mentioned in this list, nor were they mentioned as possible investments for Unigestion's portfolio in the conversations and documents described above. Inverse IOs are riskier and more complicated than the securities listed in the Guideline. It is extremely difficult to predict their performance vis-a-vis fluctuations in interest rates.

 The IMA also provided that Unigestion's portfolio would be diversified as to the issuing agency of the underlying securities. Ultimately, Federal National Mortgage Associate ("FNMA") was the issuing agency for over 60% of the underlying securities represented in Unigestion's portfolio as invested by ACM.

 The IMA required ACM to transmit to Unigestion: (a) confirmations of account transactions; (b) periodic statements received by ACM from State Street and all other account custodians and brokers; and (c) monthly reports on the Account. The monthly reports were to include (i) a portfolio position report, (ii) a statement of the change in the net asset value of the Account, and (iii) a reconciliation of such reports with statements provided by the Custodian and any other financial institutions carrying Account positions.

 The IMA also required ACM to obtain Unigestion's approval before allowing the portfolio's debt/equity ratio to exceed 5:1.

 The Guideline stated that ACM sought to "control the risks" associated with the investment program, which were non-exclusively listed as: (i) failure to identify and capitalize on the opportunity presented by mispriced securities; (ii) temporary dislocations in the CMO market due to major sentiment swings; and (iii) illiquidity. *fn2"

 The Guideline made no mention of the use of forward contracts or trades. ACM did not disclose to Unigestion the likelihood that ACM would employ forward trading strategies in managing Unigestion's portfolio. The Guideline contained no mention of the risks associated with such strategies.

 The IMA contained the following authorization provision in P 5:


Subject to the limitations, restrictions and objectives set forth in the Investment Guidelines attached hereto as Exhibit A, [Unigestion] hereby grants ACM complete discretion in the investment and reinvestment of the Account (including conversion or exercise of related rights or options with respect to assets in the Account). [Unigestion] authorizes ACM to purchase and/or sell securities, futures and other financial instruments for Unigestion's account and to act for [Unigestion] in all matters necessary or incidental to such transactions. As a general matter, ACM may effect transactions with such brokers or dealers as may, in ACM's best judgment, provide prompt and reliable execution of the transactions at favorable prices, including commission rates or dealer mark-ups.

 In addition, in P 10, certain notice requirements were imposed on ACM:


ACM will immediately notify [Unigestion] upon the occurrence of any event which would or could be material for the performance of the Agreement by ACM. Such a notification shall in particular be made in the event:


. . .


(c) ACM determines to set up any customer account or any sub-account to facilitate management of the Account.

 During the negotiation of the IMA, ACM provided a form investment management agreement to Unigestion, which Unigestion modified to include the above-quoted notice provision. Unigestion also negotiated for the inclusion of the IMA's requirement that ACM immediately notify Unigestion in the event that the Account was devalued by 25%. The IMA contained no express provision that specifically authorized ACM to open securities accounts with securities broker-dealer firms such as Kidder. Nor did the IMA give to ACM any power of attorney or other express authority that specifically empowered ACM to execute contracts on Unigestion's behalf.

 Other than the reference in P 5 to the Guideline, the IMA contains no other express, specific limitation on the ACM's authorization "to act for [Unigestion] in all matters necessary or incidental to such transactions."

 The Opening of Unigestion's Kidder Account

 Commencing February 1994, ACM/Askin opened an account with Kidder in the name of Unigestion ("Unigestion's Kidder Account"). ACM/Askin did not notify Unigestion that it had done so, and Unigestion personnel did not learn of the existence of the account until after March 30, 1994.

 At the time that this account was opened, accounts were also maintained by ACM at Kidder in the names of Granite Partners, Granite Corporation, Quartz, and other segregated accounts managed by ACM/Askin. Those accounts were highly leveraged at that time and had been having financial difficulties before February 1994, because an increase in interest rates which had begun in the United States in December 1993, had caused a decline in bond prices. That decline had triggered a deterioration of the portfolios of Granite Corporation, Granite Partners, Quartz, and the other segregated accounts managed by ACM/Askin because of the illiquid, volatile, and bullish securities they held.

 Neither ACM/Askin nor Kidder ever sent Unigestion any documents to execute concerning Unigestion's Kidder Account. Kidder documents indicate that Kidder never obtained certain documents required for the opening of such an account, including, corporate resolutions of Unigestion approving trading authority.

 Kidder never sent written confirmations of the securities transactions (described below) or account statements to Unigestion or to State Street as custodian.

 The Transactions

 Subsequent to the execution of the IMA, in February and March of 1994, ACM conducted various transactions with Kidder on Unigestion's behalf. These transactions included (i) purchases and sales of CMOs and (ii) leveraged transactions called "repos", in which a buyer purchases securities from the seller with an agreement to resell the same securities back to the buyer at a fixed price at a later date.

 The CMO investments which Askin made on Unigestion's behalf were neither nonspeculative nor of limited risk. The type of CMOs in which ACM/Askin chose to invest Unigestion's funds were high-risk securities, as compared to many common stocks, mutual funds or other derivatives. Moreover, these securities were so complicated that predicting their price sensitivity vis-a-vis fluctuating interest rates was extremely difficult, even for ACM/Askin, who had represented themselves as specialists in the CMO field. ACM/Askin did not disclose this difficulty to Unigestion.

 Beginning in February, active bidding decreased in the market for mortgage derivative securities. Beginning in March, spreads widened in the mortgage pass through market and exacerbated the problem. Because the Askin Funds' investments were leveraged, brokerage firms at which ACM/Askin had established accounts began making margin calls. To meet the margin calls, ACM/Askin was forced to sell securities into a market which was rapidly becoming illiquid and in which fewer and fewer participants were placing bids. Lack of cash and pressure to meet margin calls prevented ACM/Askin from following its hedged "market neutral" strategy with respect to the Askin Funds and other Askin managed accounts.

 Unigestion's account did not lack cash. Nevertheless, ACM/Askin purchased, financed, and sold securities for Unigestion's account--purportedly--in the same manner that it purchased, financed and sold securities for the Askin Funds and other Askin managed accounts.

 ACM/Askin had to sell securities to raise cash needed by the Askin Funds and other Askin managed accounts, not including Unigestion, and the only securities that were saleable were bearish securities: those that were increasing in value as interest rates rose. To entice Kidder to purchase the Askin Funds' securities and securities of other Askin managed accounts, ACM/Askin purchased other securities for forward settlement (which required no cash payment until March 30 or later) for the Askin Funds and other Askin managed funds, including purchases made on behalf of Unigestion.

 Securities purchased by ACM/Askin were high-margin securities, which were very profitable for brokers such as Kidder. Competition to underwrite CMOs was highly intense during the period in question, and ACM/Askin's business was heavily sought after. Kidder was the largest underwriter of CMOs, and Kidder was the broker with whom ACM/Askin did the most business during the period in question.

 In other words, it is alleged that ACM/Askin, with the participation of Kidder, used the funds deposited by Unigestion with State Street for the purpose of effectuating trades with Kidder, in order to benefit Granite Corporation, Granite Partners, Quartz, and Askin (as a shareholder of Granite Corporation and Quartz, as General Partner of Granite Partners, and as investment advisor of those entities), as well as Kidder as broker. Neither ACM/Ask in nor Kidder informed Unigestion that these purchase transactions were executed in Unigestion's name for the actual purpose of easing the way for otherwise problematic sales of securities held by the Askin Funds, for the mutual benefit of ACM/Askin and Kidder, at the expense of Unigestion. Kidder knew that Granite Corporation and Granite Partners needed cash, and in exchange for Kidder's purchase of securities from those entities, Kidder looked to ACM to purchase high-risk and potentially illiquid securities, for forward settlement, from Kidder.

 During the week of January 28, 1994, Kidder underwrote $ 1,819,809,621 of FNMA Series 1994-33 ("FN 94-33"). High risk securities were to be included in FN 94-33, and Kidder desired to sell as many of these high-risk securities as possible. Kidder designed and created FN 94-33 Class S ("FN 94-33S"), an Inverse IO, as the most high-risk and potentially most difficult to sell class of FN 94-33. On February 1, 1994, Kidder sold the entire FN 94-33 Class S issue--$ 368,634,669 worth--to ACM at a price subject to modification based on a yield maintenance formula for settlement on March 30, 1994. In exchange, Kidder purchased from the Askin Funds $ 9.3 million of FN 93 75 S, $ 1.4 million of FN 91 G15SA, and $ 900,000 of FN 91 G26S (the "First Swap Securities") with total proceeds to the Askin Funds of over $ 20 million for settlement on February 8, 1994. The purchase by ACM of FN 94-33S was executed at a manipulated price as an inducement for Kidder to purchase the first swap securities from the Askin Funds.

 On February 1, Unigestion had not opened the State Street account and, therefore, had not, in the language of the IMA "placed under the management of ACM" any securities or cash. ACM, therefore, could not have traded on Unigestion's behalf on February 1, because there was were as yet no assets with which to trade. On February 4, despite the fact that Unigestion had not owned any of the first swap securities, a purchase of $ 8,634,669 worth of the high risk FN 94-33 Class S was processed for Unigestion's Kidder Account with a trade date of February 1 (the "February 1 Trade"). No trade ticket for this purported transaction with Unigestion's Kidder Account has been produced by Kidder. A Kidder Investor Account statement, in the form used for individual and institutional customers of Kidder, for the period February 1 to February 28, 1994 ("Unigestion's Kidder Account February Statement"), does not list the purchase of FN 94-33 Class S as a transaction for Unigestion's Kidder Account during February 1994, nor does it list FN 94-33 Class S as an open position of Unigestion's Kidder Account as of February 28, 1994. The trade confirmation of this transaction indicates that the date of the trade as "2/1/94".

 An almost identical pair of transactions was executed with a trading date of February 2, 1994, involving another high-risk and potentially difficult to sell class of derivative instruments, derived from mortgage-backed securities issued by Federal Home Loan Mortgage Corporation ("FHLMC") and identified as FH 1695 Class RJ. On March 21, despite the fact that Unigestion did not own any of the securities which Kidder purchased in exchange for ACM's purchase of the FH 1695 Class RJ (the "Second Swap Securities") $ 6,000,000 of FH 1695 DJ was processed for Unigestion's Kidder Account with a trade date of February 2, 1994. As in the first transaction, no trade ticket was produced documenting this transaction. The February statement for Unigestion's Kidder Account does not list the purchase of FH 1695 DJ as a transaction for Unigestion's Kidder Account during February 1994, nor does it list FH 1695 DJ as an open position of Unigestion's Kidder Account as of February 28, 1994.

 On February 11, 1994, Kidder sold ACM another series of FNMA securities, $ 1,000,000 of which was attributed to Unigestion's Kidder Account. As with the previous trades, no trade ticket or other account documents indicate that the transaction actually was executed for Unigestion on the trade date.

 Kidder documents show a reverse repurchase/repurchase transaction ("repo") for $ 1,000,000 of FN 89 75G for Unigestion's Kidder Account on February 18, 1994. Repo transactions executed by brokers and dealers for the account of customers are subject to Exchange Act Rule 15c3-3(b)(4)(i), 17 C.F.R. § 240.15c-3(b)(4)(i), and 17 C.F.R. § 403.4. This Rule provides that a broker or dealer that retains custody of securities that are the subject of a repo transaction shall obtain a repurchase agreement in writing. No such agreement was executed by Unigestion or ACM regarding the February 18 repo transaction, which resulted in a loss of $ 122,129 by Unigestion which has not been recovered. Twelve more transactions are detailed in the Amended Counterclaims. These subsequent transactions, like the three described above, lacked trade tickets indicating that, as of the trade date, the transaction was being executed for the account of Unigestion. They all involved highly speculative investments. Some were "repos", others were "IOs". Some involved a "swap security" scenario as described above, in which ACM, for the benefit of the cash-poor Askin Funds bought highly speculative, hard-to-sell CMO securities from Kidder in exchange for Kidder's buying securities from the Askin Funds, thereby providing needed cash to the Askin Funds. ACM then attributed hundreds of thousands of dollars of the newly purchased, high-risk CMO derivatives to Unigestion's Kidder Account. The table below sets out the key details of the transactions already described and subsequent transactions. Total Price of Kidder Amount Portion Trade Date Series Transaction of Sale Attributed Date Processed Designation Type to Askin to Unigestion 2/1/94 2/4/94 FN 94 33S Inverse IO $ 368,634,669 $ 8,634,669 2/2/94 3/21/94 FH 1695RJ Inverse IO $ 300,000,000 $ 6,000,000 2/11/94 2/16/94 FN 147PN "IOette" $ 152,495,000 $ 1,000,000 2/18/94 2/24/94 FN 92 G67S Inverse IO $ 153,500,000 $ 12,500,000 2/18/94 2/23/94 FH 1344S Inverse IO $ 257,727,840 $ 17,727,844 2/23/94 2/23/94 FN 92 26S Inverse IO $ 875,000 $ 77,000 2/24/94 2/28/94 FN 92 139SA Inverse IO $ 2,400,000 $ 120,000 2/24/94 3/21/94 FH 1695D Inverse IO $ 100,000,000 $ 7,250,000 3/4/94 3/10/94 FH 1710AK Inverse IO $ 300,000,000 $ 5,000,000 3/10/94 3/14/94 FH 1534L Inverse IO $ 220,000,000 $ 5,250,000 3/25/94 unknown n3 FH G031S Inverse IO $ 35,000,000 unknown n4 n3 The date that this transaction was processed is not known since Kidder has not produced a trade confirmation for the transaction and it does not appear on any account statement. n4 Neither the Proposed Amended Complaint nor any of Kidder's submissions indicates the portion of this transaction which was allocated to Unigestion. Kidder's asserted claim growing out this transaction is $ 337,500. Trade Ticket Attributing Sale to Unigestion Was "Swap as of Trade Security" Trade Date? Involved? Date (Y/N) (Y/N) 2/1/94 No Yes 2/2/94 No Yes 2/11/94 No No 2/18/94 No Yes 2/18/94 No Yes 2/23/94 No Yes 2/24/94 No Yes 2/24/94 No Yes 3/4/94 No No 3/10/94 No Yes 3/25/94 No Yes


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