The opinion of the court was delivered by: CHIN
Raizy Levitin ("Levitin" or "plaintiff") brings this action on behalf of herself and all other persons who have conducted short sales through PaineWebber, Inc. ("PaineWebber" or "defendant") since August 15, 1992 alleging that PaineWebber, by purportedly misappropriating funds that its customers provided as collateral, engaged in securities fraud. In addition to the federal securities fraud claims, plaintiff and the putative class assert various state law claims. Defendant moves to dismiss the complaint for failure to state a claim for securities fraud under section 10(b) of the Securities and Exchange Act of 1934 ("the 1934 Act"), 15 U.S.C. § 78j(b), and, if this claim is dismissed, to dismiss the remaining claims for lack of subject matter jurisdiction. Because the alleged fraud was not perpetrated "in connection with" the purchase or sale of securities within the meaning of the 1934 Act, PaineWebber's motion is granted.
In 1994, Levitin entered into a margin agreement with PaineWebber, a registered broker-dealer. Through her PaineWebber margin account, plaintiff engaged in short sales of securities. In the typical short sale, the customer sells stock that he or she does not own. The customer usually covers the sale with stock borrowed from the broker. If the customer is able to purchase the stock later at a lower price to repay the stock to the broker, the customer will earn a profit equal to the difference between the sale price and the purchase price.
To secure the loan of stock, the customer is required to provide the broker with collateral in the form of cash or securities.
The proceeds of the short sale, which are applied toward the margin requirement, remain in the customer's account until the sale is covered.
The broker obtains the stock that it loans to the customer from its own reserves or by borrowing it from other brokers or other customers, as permitted by standard margin agreements. When the broker borrows the stock from external sources, the broker must secure the loan with collateral worth at least 100% of the market value of the securities borrowed. Regulation T, 12 C.F.R. § 220.16. The funds used to secure the loan of stock may be taken directly or indirectly from the account of the customer engaging in the short sale, and typically are generated by the short sale itself.
Where the broker has provided collateral to another broker or institution to secure the loan of securities, the borrowing broker typically receives a portion of any interest earned on the collateral, known as a "rebate." The borrowing broker does not usually pass any of the interest on to its customer, although an exception is sometimes made for large or professional customers.
In essence, the complaint alleges that PaineWebber uses its customers' assets, in the form of cash and stock collateral and proceeds of short sales, to earn interest and to obtain other financial benefits without notifying the customers of this practice or sharing the proceeds with them. Based upon these allegations, Levitin and the putative class assert claims for securities fraud, breach of fiduciary duty, breach of trust, breach of implied covenants of good faith and fair dealing, and violation of Article 9 of the Uniform Commercial Code.
A. Standard for Motion to Dismiss
In ruling upon the motion to dismiss the complaint under Rule 12(b)(6), I must view the complaint in the light most favorable to Levitin, accepting all allegations contained in the complaint as true. See Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S. Ct. 1683, 1686, 40 L. Ed. 2d 90 (1974); Annis v. County of Westchester, 36 F.3d 251, 253 (2d Cir. 1994). All reasonable inferences are to be drawn in the plaintiff's favor, and the claims should not be dismissed unless it appears beyond doubt that the plaintiff can prove no set of facts in support of her claim that would entitle her to relief. See Scheuer, 416 U.S. at 236, 94 S. Ct. at 1686 (citing Conley v. Gibson, 355 U.S. 41, 45-46, 78 S. Ct. 99, 102, 2 L. Ed. 2d 80 (1957)); Christ Gatzonis Elec. Contractor, Inc. v. New York City Sch. Constr. Auth., 23 F.3d 636, 639 (2d Cir. 1994).
B. Securities Fraud Claims
Levitin bases her securities fraud claims upon defendant's alleged violation of three rules promulgated under section 10(b) of the 1934 Act: Rule ...