Grandon v. Merrill Lynch & Co., Inc.
| Decision Date | 19 June 1998 |
| Docket Number | Docket No. 97-9027 |
| Citation | 147 F.3d 184 |
| Court | U.S. Court of Appeals — Second Circuit |
| Parties | Fed. Sec. L. Rep. P 90,228 Dr. Stanley C. GRANDON, all others similarly situated and Michael Cafferty, as Trustee for the Grandon Family Irrevocable Trust, on behalf of themselves and all others similarly situated, Plaintiffs-Appellants, v. MERRILL LYNCH & CO., INC. and Merrill, Lynch, Pierce Fenner & Smith, Inc., Defendants-Appellees. |
Christopher Lovell, Lovell & Stewart, LLP, New York City, and Jonathan Kord Lagemann, New York City, for Plaintiffs-Appellants.
A. Robert Pietrzak, Andrew W. Stern and Cathleen M. Tiernan, Brown & Wood LLP, New York City, for Defendants-Appellees.
Before: WALKER, McLAUGHLIN, Circuit Judges, and SWEET, District Judge. *
This is a class action for securities fraud against Merrill Lynch, Pierce, Fenner & Smith, Inc., a registered broker-dealer with
offices throughout the United States, and its New York-based parent company, Merrill Lynch and Co., Inc. (collectively, "Merrill Lynch"). Dr. Stanley Grandon and Michael Cafferty, trustee for the Grandon Family Irrevocable Trust (collectively, "the Plaintiffs"), maintained accounts with and purchased municipal securities from Merrill Lynch.
In an amended class action complaint in the United States District Court for the Southern District of New York (Kram, J.), the Plaintiffs asserted that Merrill Lynch committed securities fraud. The complaint alleged violations of Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b), Securities and Exchange Commission ("SEC") Rule 10b-5, 17 C.F.R. § 240.10b-5, and 15 U.S.C. § 78t(a) (controlling person liability). The complaint also included state law claims for breach of contract and breach of fiduciary duty.
The specific charge is that Merrill Lynch committed securities fraud in the sales of municipal bonds by: (1) charging the Plaintiffs excessive markups in the form of inflated prices and fees; and (2) failing to disclose either the "true market price" (the prevailing market price) of the bonds or the amount of the markups. The complaint also asserted that Merrill Lynch made implied misrepresentations or omissions by sending the Plaintiffs confirmation statements regarding the municipal bond transactions without disclosing the prevailing market prices of the bonds or the amounts of the fees imposed.
As a general rule, absent countervailing evidence, the best measure of a prevailing market price is the broker-dealer's "contemporaneous cost" for the securities, i.e., the retail market price that the dealer paid for a security in actual transactions close in time to its retail sales. A broker-dealer is entitled to add a reasonable markup on what it paid for the securities.
In alleging that Merrill Lynch charged excessive (and undisclosed) markups, the complaint set forth three specific transactions: (1) On November 22, 1994, the Plaintiffs bought 90,000 municipal bonds at $92.47 per bond. These bonds were described as "Michigan Public Power Agency Rev Ref Belle River PJ-A OID Mar 93, 5.2%, Jan 1 04 bonds." The Plaintiffs contend that Merrill Lynch charged a markup of "approximately 4.6 percent above the true market price" for the Michigan Public Power bonds. (2) On January 19, 1995, the Plaintiffs purchased 60,000 municipal bonds at $87.04 per bond. These bonds were described as "Southfield MI Pub Ses Facs Nov 93, 4.25%, May 1 04." The Plaintiffs contend that Merrill Lynch charged a markup of "approximately 6.3 percent above the true market price" for the Southfield bonds. (3) On August 25, 1995, the Plaintiffs purchased 45,000 municipal bonds at $97.414 per bond. These bonds were described as "Garden City MI Sew Disp Sys Ser B LT MBIA July 95, 5.5%, Nov. 1 11, Interest from 7/1/95, First Coupon 11/1/95." The Plaintiffs contend that the markup for the Garden City bonds was "between approximately 3.7 and 9.74 percent above the true market price" for the Garden City bonds.
Merrill Lynch moved to dismiss the complaint for lack of subject matter jurisdiction, failure to state a claim and failure to plead fraud with sufficient particularity, under Federal Rules of Civil Procedure 12(b)(1), 12(b)(6) and 9(b). With respect to the Plaintiffs' federal claims, Merrill Lynch asserted that: (1) the alleged omissions were not material; (2) the Plaintiffs did not claim reliance on the alleged omissions; (3) Merrill Lynch had no duty to disclose the information at issue; and (4) the Plaintiffs failed to allege scienter. Apparently, Merrill Lynch also asserted that the Plaintiffs failed to plead the federal claims with sufficient particularity. See Fed.R.Civ.P. 9(b). As to the Plaintiffs' state-law claims, Merrill Lynch asserted that: (1) the district court lacked jurisdiction; (2) the Plaintiffs failed to plead the claims with particularity; and (3) the Plaintiffs failed to state a claim for breach of contract.
Judge Kram granted Merrill Lynch's motion to dismiss on the ground that the Plaintiffs failed to state a claim for which relief Judge Kram did not address whether Merrill Lynch made fraudulent misrepresentations or omissions in the transaction confirmation statements it sent to the Plaintiffs. Also, because she dismissed the complaint under Rule 12(b)(6), Judge Kram did not: (1) rule on whether the Plaintiffs met the stringent pleading requirements of Federal Rule of Civil Procedure 9(b); or (2) decide the merits of Merrill Lynch's statute of limitations defense. Declining to exercise pendent jurisdiction over the Plaintiffs' state law claims, Judge Kram dismissed the complaint in its entirety.
could be granted. Fed.R.Civ.P. 12(b)(6). This decision was based solely on the conclusion that Merrill Lynch had no duty to disclose the markups. In her opinion and order, Judge Kram acknowledged that the size of the bond markups was material, stating that "a reasonable investor would have considered disclosure of the fees [which Judge Kram found amounted to $3,885.30, $3,096, and $3,663] important." Judge Kram also presumed that the Plaintiffs relied on the information because "[p]ossession of the omitted information as to the true market price and fee could well have induced [P]laintiffs to seek better terms from Merrill Lynch or other brokers." Judge Kram then held, however, that Rule 10b-5 was not violated because Merrill Lynch had no statutory or regulatory duty to disclose the markups. Finally, Judge Kram concluded that because Merrill Lynch was under no affirmative duty to disclose the alleged omissions, it did not act with scienter in failing to disclose the markups
The Plaintiffs appeal. We now vacate and remand.
The Plaintiffs contend that Judge Kram erred in dismissing their securities fraud claim under Rule 12(b)(6), primarily for two reasons: (1) under the circumstances, Merrill Lynch had a duty to disclose the "true market price" or markups of the municipal securities sold to the Plaintiffs, and failed to do so; and (2) Merrill Lynch made implied, material misrepresentations by not revealing the markups on the relevant confirmation statements it sent to the Plaintiffs. The sole basis for Judge Kram's dismissal was the Plaintiffs' first ground for appeal. Because Merrill Lynch would indeed have had a duty to disclose any excessive markups on the municipal securities, we vacate and remand. We do not reach the Plaintiffs' second ground for appeal, which was not decided below.
We review de novo a district court's dismissal of a complaint pursuant to Rule 12(b)(6). See, e.g., Chill v. General Electric Co., 101 F.3d 263, 267 (2d Cir.1996). In reviewing such a dismissal, we accept as true the factual allegations made in the complaint and draw all inferences in favor of the plaintiffs. Mills v. Polar Molecular Corp., 12 F.3d 1170, 1174 (2d Cir.1993) (citing IUE AFL-CIO Pension Fund v. Herrmann, 9 F.3d 1049, 1052 (2d Cir.1993)). Moreover, "[t]he district court should deny the motion [to dismiss] unless it appears to a certainty that a plaintiff can prove no set of facts entitling him to relief." Ryder Energy Distribution Corp. v. Merrill Lynch Commodities, Inc., 748 F.2d 774, 779 (2d Cir.1984).
Section 10(b) of the Exchange Act prohibits sellers of securities from employing "any manipulative or deceptive device or contrivance in contravention of [SEC] rules and regulations." 15 U.S.C. § 78j(b). SEC Rule 10b-5, promulgated under § 10(b), makes it unlawful to make material misstatements or to omit material facts in connection with the purchase or sale of any security. 17 C.F.R. § 240.10b-5. Section 10(b) and the complementary Rule 10b-5 "substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus ... achieve a high standard of business ethics in the securities industry." Affiliated Ute Citizens v. United States, 406 U.S. 128, 151, 92 S.Ct. 1456, 31 L.Ed.2d 741 (1972) (footnote omitted); S.E.C. v. First Jersey Securities, Inc., 101 F.3d 1450, 1466 (2d Cir.1996), cert. denied, --- U.S. ----, 118 S.Ct. 57, 139 L.Ed.2d 21 (1997).
To establish liability under § 10(b) and Rule 10b-5, a plaintiff must prove that: (1) in connection with the purchase or sale of a security; (2) the defendant, acting with scienter; (3) made a material misrepresentation or (where there exists a duty to speak) a material omission, or used a fraudulent device. See, e.g., First Jersey, 101 F.3d at 1467; In re Time Warner Inc. Securities Litigation, 9 F.3d 259, 264 (2d Cir.1993); Brown v. E.F. Hutton Group, Inc., 991 F.2d 1020, 1031 (2d Cir.1993); McMahan & Co. v. Wherehouse Entertainment, Inc., 900 F.2d 576, 581 (2d Cir.1990).
In the case of an omission, the duty to disclose generally "arises when one party has information that the other [party] is entitled to...
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