Bischoff v. GK Scott & Co., Inc., CV 85-4677.

• Decision Date: 29 August 1986
• Docket Number: No. CV 85-4677.,CV 85-4677.
• Citation: 687 F. Supp. 746
• Parties: John H. BISCHOFF, Jr., Plaintiff, v. G.K. SCOTT & CO., INC., George Kevorkian, and Irv J. Fischer, Defendants.
• Court: U.S. District Court — Eastern District of New York

687 F. Supp. 746

John H. BISCHOFF, Jr., Plaintiff, v. G.K. SCOTT & CO., INC., George Kevorkian, and Irv J. Fischer, Defendants.

No. CV 85-4677.

United States District Court, E.D. New York.

August 29, 1986.

Hayt, Hayt & Landau, Great Neck, N.Y. (Clifford J. Chu, P.C., of counsel), for plaintiff.

Ormsten & Evangelist, New York City (Franklin D. Ormsten, of counsel), for defendants.

MEMORANDUM OF DECISION AND ORDER

MISHLER, District Judge.

Plaintiff brings this action seeking damages for securities fraud and civil RICO violations. Defendants move to dismiss the action for failure to state a claim upon which relief can be granted and failure to plead fraud with requisite particularity. For the reasons set forth below the claims are dismissed.

FACTS

Plaintiff John H. Bischoff, Jr. ("Bischoff") is an unsophisticated investor.¹ At all relevant times, defendant G.K. Scott & Co., Inc. ("Scott") was a registered broker-dealer with the Securities and Exchange Commission ("SEC") and a member of the National Association of Securities Dealers, Inc. Defendant George Kevorkian ("Kevorkian") is president of Scott and a "controlling person" of defendants Scott and Fischer. Defendant Irv J. Fischer ("Fischer") is a registered representative employed by Scott.

In April 1983 plaintiff opened an account with defendants at Fischer's suggestion. The account was originally funded with six securities worth approximately $68,000. Plaintiff told Fischer that because he needed money for his children's college expenses, he wanted to limit speculative transactions to $10,000. Fischer agreed. Based on this representation by Fischer, plaintiff opened the account. At no time did he provide discretionary authority to defendants with respect to the account. As alleged by plaintiff, Fischer never intended to so limit speculative trading but misrepresented his intentions in order to induce plaintiff to open the account.

On the day after plaintiff delivered his six securities, defendants, contrary to plaintiff's instructions and without plaintiff's knowledge, sold five of them and within the next month purchased three speculative over-the-counter securities² for which Scott acted as market-maker, a status which was noted on plaintiff's monthly statements dated April 30 and May 31, 1983.

Continuing through April 1985, defendants made further unauthorized purchases of speculative securities without disclosing their risky nature. While plaintiff received monthly statements informing him of these transactions, defendants did not inform plaintiff that they "dominated and controlled the market price for such securities, and that such prices did not bear any relationship to such securities' intrinsic worth."

Noticing the declining value of his account, plaintiff requested, first in December 1983 and again in April 1984, that defendants liquidate his account. On both occasions Fischer advised plaintiff to retain the securities because they would increase in value. Plaintiff acquiesced, relying on Fischer's expertise. Finally, in the spring of 1985, after the account's value had substantially declined, plaintiff directed defendants to liquidate. At the time this action was filed in December 1985 defendants had not fully complied, and the account contained one security for which no price was available.

Had not defendants made "fraudulent material misrepresentations and omissions," plaintiff claims, he "would not have opened the account with defendants." Complaint at ¶ 18.

DISCUSSION

Plaintiff's complaint alleges violations of Sections 12 and 15 of the Securities Act of 1933, 15 U.S.C. §§ 77l and 77o; Sections 10(b) and 20 of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b) and 78t and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder; and civil RICO claims pursuant to 18 U.S.C. § 1961 et seq. The securities fraud claims rest upon allegations of misrepresentation, non-disclosure, and mismanagement of plaintiff's account through unauthorized trades. The RICO claim is based upon the same events.

THE SECURITIES FRAUD CLAIMS

To state a Rule 10b-5 claim, plaintiff must allege that defendant:

1. misrepresented or omitted to disclose a material fact;

2. in connection with the purchase or sale of any security;

3. with the requisite scienter — i.e., knowledge or reckless disregard of its falsity, or an intent to deceive;

4. that plaintiff reasonably and detrimentally relied on the defendants' misrepresentations or omissions; and 5. that defendant used the mails or an instrumentality of interstate commerce or a facility of any national securities exchange.

First Virginia Bankshares v. Benson, 559 F.2d 1307, 1314-15 (5th Cir.1977), cert. denied, 435 U.S. 952, 98 S.Ct. 1580, 55 L.Ed. 2d 802 (1978); Jaksich v. Thomson McKinnon Securities, Inc., 582 F.Supp. 485, 493 (S.D.N.Y.1984). We discuss in turn each of plaintiff's allegations.

Fraud in Opening of the Account

Plaintiff claims that defendants' misrepresentation of their intention to abide by the $10,000 limitation on speculative trading, made at the inception of the account, satisfies the requisite elements. The defendants contend that such a misdeed amounts to a mere breach of contract or failure to follow a customer's directions. We agree that the alleged fraud at the opening of the account fails to state a claim under Rule 10b-5.

It is well settled that allegations of a mere breach of contract or breach of fiduciary duty, without more, do not state a claim under Section 10(b) or Rule 10b-5. Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 476-77, 97 S.Ct. 1292, 1302-03, 51 L.Ed.2d 480 (1977); Shemtob v. Shearson, Hammill & Co., 448 F.2d 442, 445 (2d Cir.1971). Remedies for such violations are generally sought under state laws or through arbitration proceedings established by the various exchanges. In order to come under the protection of the federal securities laws a plaintiff must allege fraud, and that fraud must be in connection with the purchase or sale of a security. See Shemtob, supra, 448 F.2d at 445 (garden variety customers' suits against brokers cannot be bootstrapped into federal securities laws violations "in the absence of allegation of facts amounting to scienter, intent to defraud, reckless disregard for the truth, or knowing use of a device, scheme or artifice to defraud").

In general, misrepresentations made by brokers inducing the opening of an account are not actionable under the federal securities laws. Because such broker misrepresentations are connected to the broker's efforts to attract the investor's business, and are not tied to a particular trade, they do not meet the Rule 10b-5 requirement that an actionable misrepresentation be in connection with the purchase or sale of securities. See, e.g., Darrell v. Goodson, 1979-80 Transfer Binder Fed.Sec.L.Rep. (CCH) ¶ 97,349 at 97,325 (S.D.N.Y. Apr. 10, 1980) (broker's promise of conservative and prudent management found to be "in connection with defendants' efforts to attract plaintiffs' brokerage business rather than with any subsequent trade in a particular security"); Troyer v. Karcagi, 476 F.Supp. 1142, 1149 (S.D.N.Y.1979) (misrepresentation of broker's intent to manage account in plaintiffs' best interests "affected the investors' confidence in a person selected by them to be their fiduciary rather than influencing their decision to purchase or sell particular securities"). Such is the case here. While Fischer's statement that he would limit trades in accordance with plaintiff's instructions may have induced plaintiff to open the account, the statement was not connected to an actual purchase or sale of securities.

Fraudulent statements in such circumstances will meet the "in connection with" requirement only in a few, limited situations. Where the underlying account is a discretionary account,³ for example, the account itself may be an investment contract,⁴ or a common enterprise, and may constitute a "security" within the purview of the federal securities laws. See In re Cantanella and E.F. Hutton & Co. Securities Litigation, 583 F. Supp. 1388, 1413 (E.D.Pa.1984) (concluding that the choice of a broker for a discretionary account "is tantamount to the choice of securities"); see also Savino v. E.F. Hutton & Co., 507 F.Supp. 1225, 1239-40 (S.D.N.Y.1981).

A fraudulent promise made to induce the opening of a brokerage account may also satisfy the "in connection with" requirement where the promise itself represents part of the consideration for a securities transaction. Pross v. Katz, 784 F.2d 455, 457 (2d Cir.1986) ("specific promise to perform a particular act in the future while secretly intending not to perform may violate section 10(b) if the promise is part of the consideration for a sale of securities"). See Walling v. Beverly Enterprises, 476 F.2d 393, 396 (9th Cir.1973) (section 10(b) fraud cognizable where person enters "into a contract of sale with the secret reservation not to fully perform it"); A.T. Brod & Co. v. Perlow, 375 F.2d 393, 397 (2d Cir. 1967) (customer's intention to pay for purchased securities only if value rose violated § 10(b)); Commerce Reporting Co. v. Puretec, Inc., 290 F.Supp. 715, 719 (S.D.N.Y. 1968) (fraud stated under § 10(b) where defendants contracted to sell their stock without any intention of doing so if they could find a higher price from another purchaser).

In the case before us, however, neither of these situations is alleged. Plaintiff's brokerage account may not be viewed as a "security" since it was neither discretionary nor an investment contract. In fact, plaintiff states quite emphatically that he "never provided discretionary authority to defendants at any time with respect to the account." Complaint at ¶ 10. Neither may Fischer's promise to limit speculative trading be viewed as consideration for a contract to sell or purchase securities since it influenced, not a securities trade, but merely plaintiff's decision to open his nondiscretionary...