Chanoff v. US Surgical Corp., Civ. No. 3:93CV01522 (AHN).

Decision Date04 January 1994
Docket NumberCiv. No. 3:93CV01522 (AHN).
CourtU.S. District Court — District of Connecticut
PartiesWilliam CHANOFF, et al., Plaintiffs, v. UNITED STATES SURGICAL CORP., et al., Defendants.

COPYRIGHT MATERIAL OMITTED

Gregory Markel, Michael Carlinsky, Barbara Moses, Orrick, Herrington & Sutcliffe, New York City, Thomas Byrne, Pullman & Comley, Bridgeport, CT, for plaintiffs.

Charles Sims, Dale Schreiber, Walter Bard, Proskauer, Rose, Goetz & Mendelsohn, New York City, Patricia Carpenter, Joan Kupersmith, Joy Beane, James Stapleton, Day, Berry & Howard, Stamford, CT, for defendants.

RULING ON MOTION TO DISMISS

NEVAS, District Judge.

The plaintiffs, William, David and Rachel Chanoff, and Harriet Fingerote ("plaintiffs"), bring this action against the defendants, United States Surgical Corporation ("USSC"), Leon Hirsch, Turi Josefsen, Bruce C. Lustman and Marianne Scipione (collectively "defendants"), alleging federal and state claims of securities fraud.

Presently pending is the defendants' motion to dismiss all counts of the complaint doc. # 18. For the reasons that follow, the motion is granted with respect to Counts III, IV, V, VIII and David Chanoff's, Rachel Chanoff's and Harriet Fingerote's claims contained in Counts I, II, VI and VII. The motion is denied with respect to William Chanoff's claims contained in Counts I, II, VI and VII only insofar as he claims damages flowing from his purchase of 2000 shares of USSC stock.

STANDARD OF REVIEW

When considering a Rule 12(b)(6) motion to dismiss, the court is required to accept as true all factual allegations in the complaint and draw inferences from these allegations in the light most favorable to the plaintiff. See Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 1686, 40 L.Ed.2d 90 (1974); Easton v. Sundram, 947 F.2d 1011, 1014-15 (2d Cir.1991), cert. denied, ___ U.S. ___, 112 S.Ct. 1943, 118 L.Ed.2d 548 (1992). Dismissal is warranted only if, under any set of facts that the plaintiff can prove consistent with the allegations, it is clear that no relief can be granted. See Hishon v. King & Spalding, 467 U.S. 69, 73, 104 S.Ct. 2229, 2232, 81 L.Ed.2d 59 (1984); Frasier v. General Elec. Co., 930 F.2d 1004, 1007 (2d Cir.1991). "The issue on a motion to dismiss is not whether the plaintiff will prevail, but whether the plaintiff is entitled to offer evidence to support his or her claims." United States v. Yale New Haven Hosp., 727 F.Supp. 784, 786 (D.Conn.1990), citing Scheuer, 416 U.S. at 232, 94 S.Ct. at 1683.

FACTS

With this standard in mind, the facts as alleged by the plaintiffs are as follows. The plaintiff William Chanoff is a former director of USSC; the plaintiffs Rachel Chanoff, David Chanoff and Harriet Fingerote are, respectively, William Chanoff's daughter, son and close friend. The individual defendants are directors and officers of USSC. As of January, 1992, the plaintiffs held approximately 400,000 shares of USSC stock. In the face of rising competition, USSC developed and implemented a third-party system of distribution (the "Just in Time Program," or "JIT") that radically changed the process by which USSC sold and distributed its products and had the following impact: 1) JIT caused a temporary surge in sales which was followed by a sharp slump, 2) the program required USSC to sell at discount to distributors thereby depressing long-term profit margin and 3) additional sales were lost due to the elimination of the direct interaction between the USSC sales force and customers which had been an effective sales tool in the past.

Plaintiffs allege that USSC top executives caused USSC to conceal the competitive pressures and the implementation of the JIT program, as well as the financial impact of both of these factors. Plaintiffs contend that USSC not only omitted reference to these facts in their reports, but also affirmatively misled investors by denying suggestions that competition was a problem, continuing to refer to its direct sales efforts and predicting unrealistic future sales growth. In addition, plaintiffs allege that defendant Scipione specifically misled William Chanoff through false and misleading statements made to him in personal letters and telephone conversations. At the same time, defendants sold over 1.7 million shares of personally owned USSC stock.

As a result of the defendants' misrepresentations, plaintiffs allege that they refrained from selling or hedging USSC stock in 1992, and borrowed against their stock in margin accounts. In addition, plaintiff William Chanoff, purchased 2000 shares of USSC stock in October of 1992. On April 7, 1993, USSC acknowledged that it had implemented the JIT program and that the program would have a negative impact on the company's financial performance, particularly in the second and third quarters. After this disclosure, the stock lost almost 1/3 of its market value in a single day. Plaintiffs allege that after the disclosure, their stock holdings dropped in value from $50 to $12 million, and William Chanoff suffered emotional distress and an immediate decline in his health.

DISCUSSION

Defendants' arguments are threefold: (1) the state claims for the defendants' failure to disclose to William Chanoff should be dismissed as they are preempted by the federal securities laws, (2) the state claims should be dismissed on state law grounds and (3) the federal claims are not viable to the extent that they seek damages for shares neither purchased nor sold. These arguments shall be addressed seriatim.

I. State Claims

The plaintiffs' state claims are as follows: in Counts I and II, plaintiffs allege causes of action sounding in common law fraud; in Count III, plaintiffs allege state common law claims for breach of fiduciary duty; in Counts IV and V, plaintiffs allege state common law claims for negligent misrepresentation and negligence; and in Count VIII, plaintiffs allege breach of the Connecticut Uniform Securities Act, Conn.Gen.Stat. § 36-472. The state claims are based on both pendent and diversity jurisdiction. The defendants seek to dismiss all of these claims.

A. Preemption

The defendants argue that the plaintiffs' state claims for fraud, negligence and breach of fiduciary duty are preempted by the federal securities laws to the extent that the state claims are premised on the defendants' alleged duty to disclose inside information to William Chanoff. Such a duty, defendants argue, is directly inconsistent with federal securities law which prohibits selective disclosure and which is designed to foster an honest market in which investors have equal access to information. The court only partially agrees.

Generally, preemption is a question of congressional intent. Federal law preempts state law only when Congress acts to "occupy the field," or when the state claims are in direct conflict with the federal law. Florida Lime & Avocado Growers v. Paul, 373 U.S. 132, 142-43, 83 S.Ct. 1210, 1217, 10 L.Ed.2d 248 (1963), reh'g denied, 374 U.S. 858, 83 S.Ct. 1861, 10 L.Ed.2d 1082 (1963). It is settled, however, that Congress did not act to occupy the field of securities; rather, the federal law preserved the states' broad powers to regulate areas within the field. See, e.g., Baker & Watts v. Miles & Stockbridge, 876 F.2d 1101, 1106 (4th Cir. 1989). Thus, to find preemption in this instance, the court must find actual conflict between the state and federal laws; that is, either that compliance with both state and federal law is impossible, or that the state law obstructs the congressional objectives underlying the federal law. See Florida Lime & Avocado Growers, 373 U.S. at 142-43, 83 S.Ct. at 1217; Baker & Watts, 876 F.2d at 1106; Donmar v. Southern Nat'l Bank, 828 F.Supp. 1230, 1234-35 (W.D.N.C. 1993). It should be noted that the fact "that state common law proscribes certain behavior considered legal under the federal act is not dispositive," Seoud v. E.F. Hutton & Co., 720 F.Supp. 671, 680 (N.D.Ill.1989), because states are free to impose more restrictive standards than the federal standards. Indeed, courts should apply a presumption against preemption when the underlying state law concerns an area of traditional state regulation such as public health and safety. See, e.g., H.P. Welch Co. v. New Hampshire, 306 U.S. 79, 84, 59 S.Ct. 438, 440, 83 L.Ed. 500 (1939). However, preemption is compelled where "states require behavior prohibited by federal enactments." Seoud, 720 F.Supp. at 680. In Baker & Watts, for example, the court found that while state common law claims are not expressly preempted by the federal securities laws, the plaintiff's state claim for indemnification was preempted as it was inconsistent with federal securities law which does not provide for such relief. Baker & Watts, 876 F.2d at 1107. See also Donmar, 828 F.Supp. at 1236-38 (finding common law claims of negligence and wrongful payment preempted by Federal Reserve Board Regulation J.)

Similarly, here, the court does not find that the plaintiffs' common law claims are per se preempted. Insofar as the claims are premised on the defendants' duty to disclose to the public and shareholders generally, such claims may be entirely consistent with the federal securities regulatory scheme.

The court agrees, however, that to the extent that plaintiffs' state claims are based on defendant Scipione's duty to disclose to William Chanoff during their personal exchanges, these claims are preempted by the federal securities laws which proscribe such selective disclosure. Cf. In re Cady, Roberts & Co., 40 SEC 907; 1961 WL 3743, *6 (1961) (finding that insider's duty to abstain or disclose under federal securities laws superseded any fiduciary obligations broker/insider had to his customers). See also Bateman Eichler v. Berner, 472 U.S. 299, 105 S.Ct. 2622, 2630, 86 L.Ed.2d 215 (1985); (selective disclosure by insider often constitutes breach of fiduciary duty to corporation); Elkind v. Liggett & Myers, Inc....

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