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FRIEDMAN v. WHEAT FIRST SECURITIES INC.

September 14, 1999

PHILIP FRIEDMAN AND CARL DEFREITAS, PLAINTIFFS,
v.
WHEAT FIRST SECURITIES INC., DEFENDANT.



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

  OPINION

Defendant Wheat First Securities, Inc. ("Wheat First") has moved pursuant to Federal Rule of Civil Procedure 12(b)(6) to dismiss the complaint filed by plaintiffs Philip Friedman ("Friedman") and Carl DeFreitas ("DeFreitas") or alternatively, stay the action pending the completion of arbitration proceedings. For the reasons hereinafter stated, Wheat First's motion to dismiss the complaint is granted.*fn1

BACKGROUND

On December 9, 1998, plaintiffs filed a complaint in this Court alleging violations of Sections 10(b) and 20 of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j and 78t, Rule 10b-5, 17 C.F.R. § 240.10b-5 and the common law.

I. The Parties

Plaintiff Friedman is a New Jersey resident and the co-owner with Charles Gray ("Gray") of the All Star Bagel Café ("Café"), a business located in Washington Township, New Jersey. Plaintiff DeFreitas was and currently is their accountant and is also a New Jersey resident.

Defendant Wheat First is a Virginia corporation with its principal place of business in the city, county and state of New York. It is a registered securities broker and dealer and a member of the New York Stock Exchange ("NYSE") and the National Association of Securities Dealers, Inc. ("NASD").*fn2

II. Alleged Misrepresentations and Plaintiffs' Reliance Thereon

The complaint alleges that in November 1996, Robert J. Cohan, who was at that time a representative of Wheat First, made various statements to Friedman and Gray, which were also communicated to DeFreitas, concerning Zitel, a developer of computer software applications, in the hope that Friedman and Gray would open brokerage accounts with Cohan at Wheat First. Cohan made statements to Gray, Friedman, DeFreitas and other patrons at the Café, claiming that Zitel, through its investment in another company, had developed the solution to the "year 2000 problem" (the inability of existing computers to recognize the change in date from year 1999 to year 2000) and would become "the next Intel."

In addition, Cohan stated that Wheat First was a major market maker in Zitel and that he had access to "first hand knowledge about where the stock was going." Specifically, Cohan told Friedman and Gray that he had access to two senior Zitel officers named King and Harris who provided information to Cohan about the company.

Cohan also told Gray, Friedman and DeFreitas that announcements would be made that Zitel had signed contracts with "Manor Care" and "Chubb" to handle their "year 2000 problem." Cohan told them that in reaction to this announcement, Zitel stock would increase in price to between $50 and $80 by the end of 1996, and to $150 by mid-1997.

According to plaintiffs, Cohan had no basis in fact to make any of his statements concerning Zitel. Furthermore, he failed to disclose that a Wheat First trader told him that Wheat First would cease to be a market maker in Zitel due to the company's volatility, and because Wheat First had incurred large losses by investing in Zitel. Cohan also failed to inform plaintiffs that Wheat First had no securities analysts or senior officers assigned to cover Zitel. Cohan's only real source of information, unbeknownst to plaintiffs, was publicly disseminated news letters and periodicals. Furthermore, Cohan never disclosed negative information about Zitel appearing in financial periodicals or Zitel's reports filed with the Securities and Exchange Commission.

In reliance on Cohan's statements, Friedman sold shares of another stock he owned, and purchased 4,000 shares of Zitel on or about January 2, 1997, through his account at Charles Schwab & Co., Inc. (the "Schwab Account") at a price of approximately $48 per share. On January 24, 1997, after selling additional shares of another stock he owned, Friedman purchased another 2,000 shares of Zitel through his Schwab Account at a price of approximately $43 per share. Friedman continues to own the shares of Zitel and estimates that he has incurred losses exceeding $500,000.

Relying on Cohan's statements, DeFreitas purchased 1,000 shares of Zitel on December 24, 1996 through his account at Charles Schwab & Co., Inc. DeFreitas initially sold his shares of Zitel at a profit, but then bought them back based on statements made by Cohan that the stock would be worth $150 by mid-1997 and that Zitel was entering into a joint venture with IBM. In April 1997, Zitel stock suffered a "precipitous decline" in price. As a result, Schwab liquidated DeFreitas' position in Zitel at a price of approximately $14 per share when DeFreitas was unable to meet a margin call. DeFreitas incurred losses of $75,723, exclusive of margin interest charges.

III. The Arbitration Proceeding

Friedman, DeFreitas and Gray (the "arbitration claimants") filed a Statement of Claim with the NASD Office of Dispute Resolution on or about September 17, 1997, alleging fraudulent misrepresentations and omissions of material fact made by Cohan about Zitel. See Affidavit of Edwin A. Zipf, Ex. A ("Zipf Aff."). Wheat First and Cohan filed a joint answer on or about January 9, 1998. At the same time, Wheat First filed an executed Submission Agreement which stated, among other things, that the parties agreed to present the matter to arbitration "in accordance ...


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