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FEZZANI v. BEAR

April 6, 2004.

MOHAMMED FEZZANI, CIRENACA FOUNDATION, DR. VICTORIA BLANK, LESTER BLANK, JAMES AND JANE BAILEY, BAYDEL LTD., MARGARET AND PATRICK BURGESS, BOOTLESVILLE TRUST and ADAM CUNG, Plaintiffs, -against- BEAR, STEARNS & COMPANY, INC., BEAR STEARNS SECURITIES CORP., RICHARD HARRITON, ANDREW BRESSMAN, ARTHUR BRESSMAN, RICHARD ACOSTA, GLENN O'HARE, JOSEPH SCANNI, BRETT HIRSCH, GARVEY FOX, MATTHEW HIRSCH, RICHARD SIMONE, CHARLES PLAIA, JOHN McANDRIS, JACK WOLYNEZ, ROBERT GILBERT, FIRST HANOVER SECURITIES, INC., BANQUE AUDI SUISSE GENEVE, FOZIE FARKASH, RAWAIRAES, BASEL SHABLAQ, KEN STOKES, ISSAC R. DWECK, INDIVIDUALLY and as custodian for NATHAN DWECK, BARBARA DWECK, MORRIS L DWECK, RALPH L DWECK, MILLO DWECK, BEATRICE DWECK, RICHARD DWECK, JACK DWECK, ISSAC B. DWECK, HANK DWECK, MORRIS WOLFSON, ARIELLE WOLFSON, AARON WOLFSON, ABRAHAM WOLFSON, TO VIE WOLF-SON, ANDERER ASSOCIATES, BOSTON PARTNERS, WOLFSON EQUITIES, TURNER SCHARER, CHANA SASHA FOUNDATION, UNITED CONGREGATION MESARAH, FAHNESTOCK & CO., INC., DONALD & CO., BARRY GESSER, MICHAEL RYDER and APOLLO EQUITIES, Defendants


The opinion of the court was delivered by: RICHARD CASEY, District Judge

Memorandum Opinion & Order

This action was brought on February 2, 1999 by eleven investors (collectively, `Plaintiffs") against more than fifty individual and corporate defendants (collectively, "Defendants") arising out of the activities of A.R. Baron & Co. ("Baron"), a New York securities broker-dealer. The complaint alleges claims for federal securities fraud, violations of the Racketeer Influenced and Corrupt Organizations Act ("RICO"), aiding and abetting breach of state-law fiduciary duties, and common-law fraud. Now before the Court are seven motions to dismiss the complaint. As detailed below, the motions are GRANTED IN PART AND DENIED IN PART.

I. BACKGROUND

  A. Baron's History

  Baron was a broker-dealer which operated from 1992 until 1996.*fn1 (Compl. ¶ 1.) During that period, Baron and its employees engaged in a widespread fraudulent scheme to manipulate the price of certain securities. The majority of Baron's business consisted of underwriting securities for initial public offerings. (Id. ¶ 5.) Baron brokers used cold calling to sell as much stock as possible in the companies. Because there was no true public market for the stocks, they were able to control both purchases and sales. (Id. ¶ 7.)

  Baron first sought to increase sales by disseminating favorable information about the stocks while suppressing adverse information, as well as inventing favorable information. (14 ¶ 8.) In addition, Baron made unauthorized purchases on behalf of customers. (Id.) When customers complained about the purchases, Baron transferred the securities to an "error account," effectively making Baron the purchaser of those securities and depleting its capital. (Id. ¶ 18.) Alternatively, Baron would rebill the unauthorized trade to a different customer's account. (Id. ¶ 21.) Baron also engaged in "parking" stock. (Id.) "Parking" is defined in the complaint as executing trades to a buyer, actually a coconspirator, by which the stock would be placed in the coconspirator's account while Baron maintained the risk of loss. The transactions would be reported to create a false appearance of trading in certain securities, thereby increasing the securities' price and inducing customers to execute transactions. (Id. ¶¶ 120-23.)

  These acts of manipulation were intended to inflate the market price of the securities that Baron was selling and convince customers to purchase those stocks. Baron and its coconspirators then sold the shares they held before the stock price crashed. (Id. ¶ 10-11.) As stated above, however, Baron's practices caused its capital to decrease, placing it in constant danger of dipping below the minimum capital level required by regulations. (Id. ¶ 23.) The National Association of Securities Dealers ("NASD") and the Securities and Exchange Commission ("SEC") investigated Baron on a number of occasions, imposing large fines and temporarily suspending some of its brokers. (Id. ¶ 94.) By the end of 1995, Baron had a net capital deficiency of $1,110,675; customer complaints amounted to $80 million. (Id. ¶ 247.) Baron temporarily went out of business in October 1995, as it had previously done in 1993. (ld.) The company finally filed for bankruptcy in July 1996. (Id.)

  The complaint alleges that Baron's activities cost investors in excess of $80 million and inflated the market value of the securities that Baron manipulated by billions of dollars. (Id. ¶ 24.) Baron's activities generated litigation, both civil and criminal, in more than one federal district court, the bankruptcy courts, New York state supreme court, and before arbitral tribunals. In 1994, a federal civil suit was filed against Baron; the NASD initiated another investigation; and an arbitration proceeding was commenced seeking over $1 million in damages. (Id. ¶ 116.) By the end of 1994, the numerous litigation actions sought over $10 million in damages. (Id.) In 1995, an investor brought another suit in federal court against Baron and some of its brokers seeking $1 million in compensatory and $5 million in punitive damages, (Id. ¶ 212.) On December 19, 1995, the State of Alabama procured an order to show cause why Baron's broker license should not be suspended for failure to report claims and proceedings against it. (Id. ¶ 231.)

  Baron's woes did not end with its 1996 bankruptcy. In March 1997, the NASD filed a complaint against eighteen Baron representatives. (Id. ¶ 269.) Then, on May 13, 1997, Baron and its employees were indicted by a grand jury in New York Supreme Court, New York County. (Id. ¶ 270.) All of the defendants in that criminal case either pled guilty or were convicted of charges of, among other things, enterprise corruption, the state-law analogue to RICO. (Id. ¶¶ 271-72.)

  B. The Manipulated Securities

  The claims here arise out of public offerings of stock in the following companies: Cryomedical Sciences, Inc. ("CMSI"), Health Professionals, Inc. ("HPI"), Cypros, Innovir, Voxel, Cardiac Sciences, Inc. ("Cardiac"), PaperClip, Mammo, Symbollon, Aqua, Laser Video, and Jockey Club. Both CMSI and HPI were cofounded by Jeffery Weissman, who, along with Andrew Bressman, founded Baron. (Id. ¶ 64.) The complaint alleges that Weissman engaged in manipulation of CMSI and HPI stock prices before he and Bressman established Baron. (Id. ¶¶ 68-69.) After Baron's conception, its brokers began using the boiler room tactics described above to inflate the price of CMSI and HPI. (Id. ¶ 90.)

  In mid-1992, Baron acted as underwriter for Cypros, a bio-pharmaceutical company without any marketable products. (Id. ¶ 91.) Baron placed 20% of the initial public offering with itself and its coconspirators, in violation of NASD regulations. (Id. ¶ 92.) Baron also executed a large amount of purchase orders for customers who never agreed to buy Cypros shares. (Id. ¶ 93.) The NASD later sanctioned Baron for the unauthorized trading in Cypros, and suspended Baron's top executives for sixty days. (Id. ¶ 155.)

  Baron allegedly profited from the manipulation of CMSI, HPI, and Cypros stock prices. However, Baron ran into some difficulty when HPI lost its allure as an attractive investment. The SEC began an investigation of HPI in 1993, and newspaper articles appeared that accused HPI of fraud. (Id. ¶ 100.) Baron had misrepresented to customers that Hoffman-LaRoche was offering to purchase HPI, and that HPI rejected the offer because of the company's high value. (Id. ¶ 99.) Baron's involvement with HPI was publicized in Barren's Magazine, a widely read Wall Street publication. (Id. ¶¶ 101, 152.) The article caused HPI stock to drop in value, causing Baron to attempt to resuscitate the price through purchasing approximately 780,000 shares, then transferring the shares to unknowing customers or parking the shares with coconspirators. (Id. ¶ 104.) The manipulation financially strained Baron, causing its net capital to fall below the level required by the NASD and resulting in a short suspension from full trading activities. (Id. ¶ 107.)

  Baron returned to its fraudulent activities with the initial public offering of Innovir, a biomedical company with no revenue and high debts. (Id. ¶ 109.) Baron instituted the same manipulation techniques it had used with the other securities. In 1994, a new group of brokers joined Baron and began manipulating certain securities: Mammo, Symbollon, Aqua, and Laser Video. (Id. ¶ 113.) These brokers made misrepresentations to Baron customers such as telling one of the plaintiffs here that Mammo's technologies and equipment were being installed and tested at Sloan Kettering Institute. (Id. ¶ 115.) The price of Innovir rose from $21/2 per share to $4 15/16 per share; soon after Baron's bankruptcy, the price returned to $2 per share and is now virtually nothing. (Id. ¶ 245.) Voxel was another company whose initial offering Baron underwrote. (Id. ¶ 118.) Baron hid or deceptively explained Voxel's lack of revenue, high debts, and short-term cash needs. (Id. ¶ 119.) Baron's brokers used high-pressure sales tactics and unauthorized purchases to inflate the price of Voxel shares as well. Shares of Voxel common stock went from $17/8 per share to $83/16 per share, until Baron's bankruptcy when the price collapsed. (Id. ¶ 244.)

  The complaint describes the sale of Mammo shares as one of the most blatant of Baron's fraudulent enterprises. According to the complaint, the market for Mammo shares consisted entirely of Baron and its affiliates. (Id. ¶ 175.) When the price of Mammo dropped 40%, Baron created fictitious sales of 300,000 to 400,000 shares, including unauthorized customer trades. (Id.) Two such trades in 1995 involved the accounts of Diaward Steel Works Ltd. and Jose Mugrabi, neither of whom are plaintiffs in this suit. (Id. ¶¶ 185-94.) In October 1995, Diaward sued Baron for fraud. (Id. ¶ 212.)

  Also in 1995, Baron underwrote an initial public offering of PaperClip, obtaining subscriptions in excess of the maximum offering amount provided for by the terms of the initial offering. (Id. ¶ 196.) Baron used the investments beyond the maximum offering amount to support the other securities it was manipulating. (Id. ¶ 196.) Baron then used a "bait and switch" technique to procure investments from customers, ostensibly for the PaperClip stock, that would be used to fund other trades. (Id. ¶ 198.) Baron inflated the price of PaperClip stock from $2.00 to a high of $113/8 per share. (Id. ¶ 243.)

  Finally, Baron entered into a scheme in 1995 to purchase large quantities of stock in Jockey Club at inflated prices and then resell those shares to Baron customers. (Id. ¶ 233.) The Jockey Club shares were, in reality, worth very little. (Id. ¶ 234.) Baron either persuaded its customers to purchase the securities through misrepresentations and omissions, or made unauthorized trades in customer accounts. (Id. ¶¶ 238-40.)

  C. Parties to this Action

  Baron's widespread fraud is not contested. Baron is no longer in business; its principals are currently incarcerated. Baron and some of its senior executives are shielded from suit by bankruptcy proceedings. At issue here, however, is Defendants' liability for defrauding Plaintiffs, who were all Baron customers.

  1. Plaintiffs

  Plaintiffs all allege that they were defrauded into purchasing stocks whose price was a result of Baron's manipulation. They further claim that Defendants here are liable for their losses. To the extent relevant, the Court discusses the Plaintiffs' individual allegations below.

  2. Defendants

  To simplify the discussion, the Court has adopted the complaint's grouping of Defendants. While Baron and some of its top executives are not named in this suit, many of its employees are. Andrew Bressman, Arthur Bressman, Richard Acosta, Glenn O'Hare, Joseph Scanni, Brett Hirsch, Garvey Fox, Matthew Hirsch, Richard Simone, Charles Plaia, Mark Goldman, John McAndris, Jack Wolynez, and Robert Gilbert are collectively labeled as the "Baron Defendants." Andrew Bressman was Baron's President and Chief Executive Officer; he pled guilty in state court to enterprise corruption and grand larceny. (Id ¶ 27, 45.) Arthur Bressman is his father, and steered prospective initial public offerings and other deals to Baron, as well as advised his son. (Id.) All of the other Baron Defendants were Baron brokers who have since been convicted of state crimes. (Id.) Of all the Baron Defendants, only Acosta has appeared in this case. Bear, Stearns & Co., Bear Stearns Securities Corp., and Richard Harriton are described herein as the "Bear Stearns Defendants." Bear, Stearns Securities Corp., a subsidiary of Bear, Stearns & Co. (together referred to as "Bear Stearns") acted as Baron's clearing house from April 1992 through approximately February 1993, and from July 1995 through July 1996. (Id. ¶ 28.) Harriton was, at the time of the complaint, a senior director of Bear Stearns Securities Corp. and its head of clearing operations. (Id. ¶ 50.) As a clearing house, Bear Stearns processed transfers of securities and transaction payments; it was Bear Stearns responsibility to ensure that trades made through Baron were completed on the settlement date so that the securities were delivered to the customer and cash paid to the seller (Id. ¶ 79.) If a buyer or seller defaulted, Bear Stearns, as clearing house, had to pay the cash or deliver the promised securities; it then had to seek restitution from the defaulting party. (Id.)

  The complaint alleges that the Bear Stearns Defendants knew of Baron's fraudulent activities, provided financial support to Baron, and directed Baron at times to sell the manipulated securities to the public. (Id. ¶ 29.) In addition, the Bear Stearns Defendants allegedly aided Baron in arranging fictitious sales by knowingly recording them as actual trades to deceive regulatory agencies. (Id) And, at times, the Bear Stearns Defendants chose which of Plaintiffs' purchase and sale orders it would execute based on the benefit to themselves. (Id. ¶ 30.)

  Donald & Co., First Hanover Securities, and Fahnestock & Co. ("Broker Defendants") are alleged to have knowingly engaged in parking and other fictitious transactions to create the appearance of an active market in the manipulated securities. (Id. ¶ 31.)

  Isaac Dweck, Morris Wolfson, Basil Shiblaq, Ken Stokes, and Fozie Farkash are collectively labeled as the "Individual Defendants."*fn2 These defendants allegedly assisted Baron in the fraud by, among other things, providing financing and engaging in parking transactions to create the appearance of an active trading market. (Id. ¶ 32.) The Individual Defendants were permitted to sell their securities at inflated prices before the stocks crashed to their true values. (Id.)

  Finally, Plaintiffs claim that Apollo Equities, Barry Gesser, and Michael Ryder ("Apollo Defendants") paid bribes to Baron in exchange for Baron recommending that Plaintiffs and other customers purchase securities such as Jockey Club. (Id. ¶ 33.) This agreement, outlined in the discussion of the Jockey Club stocks above, allegedly was meant to, and did, artificially inflate market prices, deceive investors, and cause Plaintiffs to purchase securities at the inflated prices. (Id. ¶ 34.)

  D. The Causes of Action and the Motions to Dismiss

  Plaintiff's first claim for relief arises under section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and its implementing regulation, Rule 10b-5, 17 C.F.R. § 240.10b-5. Plaintiffs allege that they traded in the manipulated securities as a result of Defendants' fraudulent misrepresentations and omissions. (Id. ¶ 274.) Defendants' acts allegedly caused Plaintiffs to believe that the price of the stocks was the result of an orderly market, when, in fact, it was a result of Defendants' and Baron's fraudulent manipulation. (Id.) Defendants are also accused of using manipulative devices in connection with the purchase and sale of securities, and engaging in practices intended to and with the effect of defrauding Plaintiffs. (Id. ¶ 276.)

  Defendants are each alleged to have violated section 10(b) and Rule 1 Ob-5 through their own acts; Plaintiffs also claim that Defendants are liable for Baron's acts as control persons of Baron pursuant to section 20(a) and (b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78. (Id. ¶¶ 35, 279.) Plaintiffs seek damages on the first cause of action in the amount of $6,500,000. (Id ¶ 288.)

  The second cause of action alleges violations of section 9 of the Securities and Exchange Act, 15 U.S.C. § 78i. The basis of this claim is that Defendants knowingly or recklessly manipulated the market for certain securities traded on national securities exchanges, with the purpose of inducing the purchase or sale of the securities. (Id. ¶¶ 290-93.) Plaintiffs allegedly relied on the integrity of the market in executing their transactions. (Id. ¶ 291.) Damages are sought on this claim in the amount of $6,500,000.

  Third, Plaintiffs sue for violations of section 10(b) and Rule 10b-5 based on Defendants knowing or reckless market manipulation. (Id. ¶¶ 297-99.) Plaintiffs also seek $6,500,000 in damages on their third cause of action. (Id. ¶ 300.)

  Plaintiffs fourth assert claims under RICO, 18 U.S.C. § 1962. The alleged pattern of racketeering activity included "tens of thousands of acts" of securities, mail, and wire fraud. (Id. ¶ 302.) The complaint describes Baron as an enterprise and Defendants as an enterprise-in-fact; Defendants allegedly participated in both enterprises' conduct through a pattern of racketeering activity. (Id. ¶¶ 302-05.) However, the RICO claim is only pursued against the Baron Defendants. Plaintiffs again seek $6,500,000 in damages, which they argue should be trebled, plus costs and attorney's fees. (Id. ¶ 310.)

  Claims five and six are based on New York State law. The fifth cause of action alleges that Defendants aided and abetted Baron and its brokers in violating Baron's fiduciary duties to Plaintiffs. (Id. ¶¶ 315-16.) The sixth cause of action alleges common law fraud. (Id. ¶ 318-19.) Plaintiffs seek $6,500,000 in damages on both claims. (Id. ¶¶ 317, 319.)

  Seven groups of defendants have filed motions to dismiss the complaint. Generally speaking, Defendants move to dismiss on the following grounds: (1) the federal securities fraud and aiding and abetting claims are barred by the applicable statute of limitations; (2) the securities fraud and common-law fraud claims are not pled with sufficient particularity under Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. § 78u-4(b)(2); and (3) the securities fraud, aiding and abetting, and common-law fraud claims fail to state causes of action under Federal Rule of Civil Procedure 12(b)(6).*fn3 Defendants further ask that the Court not exercise supplemental jurisdiction over the state-law claims if the federal claims are all dismissed. II. DISCUSSION

  A. Legal Standard on Motions to Dismiss

  The Court can only grant a motion to dismiss pursuant to Rule 12(b)(6) if it appears beyond doubt that Plaintiffs can prove no set of facts in support of their claim that would entitle them to relief. Gant v. Wallingford Bd. of Educ. 69 F.3d 669, 673 (2d Cir. 1995). Failure to sufficiently plead the elements of a cause of action is grounds for dismissal. Golding Assocs. L.L.C. v. Donaldson, Lufkin, Jenrette & Securities Corp. 2003 WL 22218643, at *1 (S.D.N.Y. Sept. 25, 2003). Plaintiffs, alleging fraud and violations of federal securities laws, must plead the elements of their causes of action with specificity. Fed.R.Civ.P. 9(b) ("In all averments of fraud . . . the circumstances constituting fraud . . . shall be stated with particularity."); PSLRA, 15 U.S.C. § 78u-4(b)(2). In addition, it is proper to dismiss claims when it is apparent from the complaint and documents referenced therein that they are barred by the applicable statute of limitations. See In re Gen. Dev. Corp. Bond Litig., 800 F. Supp. 1128, 1135-36 (S.D.N.Y. 1992) (collecting cases).

  B. Claims Under Sections 9 and 10(b) and Rule 10b-5

  1. Statute of Limitations on Plaintiffs' Security Fraud Claims

  Defendants move to dismiss the complaint on the ground that the security fraud claims are barred by the applicable statute of limitations. Section 9 of the Securities Exchange Act of 1934 states, "No action shall be maintained to enforce any liability created under this section unless brought within one year after the discovery of the facts constituting the violation and within three years after such violation." 15 U.S.C. § 78i(e). The same limitations periods apply to claims based on § 10(b) and Rule 10b-5. Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 351, 364 (1991). Thus, the first three causes of action here are time-barred unless filed within one year from the date Plaintiffs discovered Defendants' fraud and three years from any violations of the federal securities laws.

  (a) Three-Year Prong

  The Court begins its analysis with three-year prong of the statute of limitations because its application is more straightforward. Plaintiffs cannot sue for any act of securities fraud that occurred more than three years before they filed the complaint in this See id at 363. "The three-year period is an absolute limitation which applies whether or not the investor could have discovered the violation." Jackson Life Ins. Co. v. Merrill Lynch & Co., 32 F.3d 697, 704 (2d Cir. 1994). Thus, "no claims under . . . Section 10(b) of the Exchange Act, or Rule 10b-5 may be brought more than three years after the sale or public offering from which those claims arise." Stamm v. Corp. of Lloyd's, No. 96 Civ. 5158 (SAS), 1997 WL 438773, at *4 (S.D.N.Y. Jan. 4, 1997). This is true for Plaintiffs' claims under section 9 as well. See Lampf, 501 U.S. at 363.

  The Second Circuit has held that "[t]he statute of limitations in federal securities law cases starts to run on the date that the parties have committed themselves to complete the purchase or sale transaction." Grondahl v. Merritt & Harris, Inc., 964 F.2d 1290, 1294 (2d Cir. 1992) (emphasis omitted); see also In re Colonial Ltd. P'ship Litig., 854 F. Supp. 64, 85 (D. Conn. 1994); Vassilatos v. Ceram Tech Int'l, Ltd. No. 92 Civ. 4574 (PKL), 1993 WL 177780, at *2 (S.D.N.Y. May 19, 1993). Or, as the Seventh Circuit has put it, "In securities fraud cases, the federal rule is that the plaintiffs cause of action accrues on the ...


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