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.
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. ¶¶
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.
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.
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. ¶
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.
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.
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. ¶¶
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.
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.
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.
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.
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
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.
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 ...