Craighead v. E.F. Hutton & Co., Inc.
| Decision Date | 28 March 1990 |
| Docket Number | No. 89-3289,89-3289 |
| Citation | 899 F.2d 485 |
| Parties | Fed. Sec. L. Rep. P 94,993, RICO Bus.Disp.Guide 7442 Milton C. CRAIGHEAD; Milton C. Craighead, Jr.; Randle S. Craighead; and Mark T. Craighead, Plaintiffs-Appellants, v. E.F. HUTTON & COMPANY, INC.; Robert L. Lyons; John Doe; and Mary Moe, Defendants-Appellees. |
| Court | U.S. Court of Appeals — Sixth Circuit |
Phillip D. Frederick (argued), Sachs, Nunn, Kates, Kadushin, O'Hare, Helveston & Waldman, Detroit, Mich., for plaintiffs-appellants.
Robert N. Rapp (argued), Calfee, Halter & Griswold and Roy A. Hulme, Reminger & Reminger, Cleveland, Ohio, for defendants-appellees.
Before MILBURN and BOGGS, Circuit Judges, and ENGEL, Senior Circuit Judge.
Plaintiffs Milton C. Craighead and his three sons, Milton C. Craighead, Jr., Randall C. Craighead, and Mark T. Craighead ("Craigheads" or "plaintiffs"), appeal the dismissal of their claims alleging RICO and federal securities laws violations. After allowing discovery, the district court granted the defendants' motion to dismiss pursuant to Federal Rules of Civil Procedure 9(b) and 12(b)(6). For the reasons that follow, we affirm.
Defendant Robert L. Lyons was, at all times relevant to this appeal, an account representative and employee of defendant E.F. Hutton & Company, Inc., a Delaware corporation registered with the Securities and Exchange Commission as a securities "broker-dealer." 1 Plaintiffs invested more than $868,000.00 with the defendants from 1982 through 1984.
On December 20, 1984, the Craigheads, two other individuals, and Inner City Nursing, Inc., filed a nine-count complaint that alleged that the defendants had churned their accounts and violated federal securities laws. In January 1985, the defendants moved to strike the complaint pursuant to Federal Rules of Civil Procedure 8, 11, 12, and 23. Plaintiffs moved for additional time to respond to the motion, and over the defendants' objections, the district court gave them an additional forty-five days.
On March 7, 1985, nine days before their extension was to expire, plaintiffs moved for an indefinite stay to enable them to hire new counsel and give him time to investigate the case. On March 19, 1985, the district court denied the plaintiffs' motion for an indefinite stay. It ordered them to secure new counsel immediately and to file either an amended complaint or a response to defendants' motion to strike by April 4, 1985. On May 3, 1985, the district court dismissed plaintiffs' complaint without prejudice because they had not complied with its order of March 19, 1985.
Nearly two years later, on February 13, 1987, the Craigheads filed the complaint that is the basis of this appeal. On April 27, 1987, the defendants moved to dismiss all claims on multiple grounds. The Craigheads argued that if the district court found their complaint lacking, it should allow them discovery so they could collect enough information to draft a sufficient pleading. In pretrial orders in May and August 1988, the district court granted the Craigheads' motion to compel discovery and established a discovery schedule. The district court took defendants' motion to dismiss under advisement pending completion of discovery, which was scheduled to close on November 18, 1988.
On December 13, 1988, the district court ordered plaintiffs to submit an amended complaint "pleading the factual basis for their fraud claims with particularity." On January 5, 1989, plaintiffs submitted their "First Amended Complaint" and a motion for leave to file it. Defendants challenged the proposed amended complaint on the ground that it failed to address any of the deficiencies in the original complaint.
On March 6, 1989, the district court granted plaintiffs' motion for leave to file the amended complaint. However, in the same order, the district court dismissed the case after it found that the allegations of fraud lacked the requisite particularity. Several of plaintiffs' claims were founded upon statutes and rules that did not imply private causes of action, and plaintiffs' RICO claims failed to include any predicate acts. The dismissal of the Craigheads' federal claims was with prejudice, but the dismissal of the remaining state claims was without prejudice. This timely appeal followed.
Milton Craighead was introduced to defendant Lyons, a securities dealer at the E.F. Hutton office in Pepper Pike, Ohio, in May 1982. Craighead alleges that when he agreed to allow Lyons to handle his investments, he instructed him to invest in low-risk securities to preserve the principal and generate interest income. Craighead alleges that he expressly instructed Lyons not to make any "risky investments." Craighead further alleges that Lyons represented that his principal would be safe and his investments would generate ten to fifteen percent in tax-free yields annually. Craighead and his three sons eventually transferred more than $500,000.00 to E.F. Hutton for Lyons to invest.
The Craigheads allege that Lyons completely disregarded their instructions and invested their accounts in high-risk stocks, options, and futures trading. They further allege that because Lyons acted on his own, and because E.F. Hutton did not properly supervise or train him, Lyons generated more than $40,000.00 in excessive commissions while losing approximately $82,000.00 of their principal.
In their amended complaint, the Craigheads plead the following claims:
Count 1 Churning--fraud in violation of 15 U.S.C. Secs. 77q(a), 78j(b) and 78o(c)(1); Rule 10b-5; and the National Ass'n of Securities Dealers Rules Art. III, Sec. 2;
Count 2 Unsuitable and excessive trading--fraud in violation of the above-listed statutes and rules;
Count 3 Unsuitable nature of trades--fraud in violation of the above-listed statutes and rules;
Count 4 Negligence;
Count 5 Liability of the controlling person (E.F. Hutton) in violation of 15 U.S.C. Sec. 78t;
Count 6 Negligent supervision;
Count 7 Breach of contract and breach of fiduciary duty;
Count 8 Breach of New York Stock Exchange Rule 405;
Count 9 Respondeat Superior;
Count 10 RICO, in violation of 18 U.S.C. Sec. 1962(a); mail fraud and securities fraud;
Count 11 RICO, in violation of 18 U.S.C. Sec. 1962(c);
Count 12 RICO conspiracy, in violation of 18 U.S.C. Sec. 1962(d); Count 13 Common law fraud; and
Count 14 Breach of fiduciary duty.
The district court dismissed the counts alleging churning, "unsuitable and excessive trading," and "unsuitable nature of trades" for failure to plead allegations of fraud with sufficient particularity. The district court was critical of the Craigheads' heavy reliance upon "information and belief" for factual allegations after they had been allowed discovery, as they had requested, and when many of their allegations were based upon records they should have had in their control. The district court also found that 15 U.S.C. Secs. 77q(a) and 78o(c)(1) did not provide for private causes of action, nor did New York Stock Exchange Rule 405. The district court dismissed Count 5 on the ground that if the Craigheads' securities claims failed against Lyons, their "controlling person" claim against his supervisors failed as well.
The district court also dismissed the Craigheads' RICO claims on the ground that their RICO claims were based upon allegations of fraud but they were not pleaded with the particularity required by Federal Rule of Civil Procedure 9(b). The district court also found that the Craigheads had failed to allege a pattern of predicate acts necessary to support a RICO claim.
The principal issues upon appeal are: (1) whether the district court erred in dismissing the churning claim on the basis of Federal Rule of Civil Procedure 9(b), (2) whether the district court erred in dismissing the other securities claims for failure to plead fraud with sufficient particularity and on the ground that 15 U.S.C. Sec. 77q(a) and New York Stock Exchange Rule 405 do not imply private causes of action, (3) whether the district court erred in dismissing the RICO claims for failure to plead fraud with sufficient particularity and failure to allege predicate acts, and (4) whether the district court abused its discretion in dismissing the Craigheads' federal claims with prejudice.
In evaluating a complaint in light of a Rule 12(b)(6) motion, the district court must accept all of the plaintiff's allegations as true and resolve every doubt in his favor. Hishon v. King & Spalding, 467 U.S. 69, 73, 104 S.Ct. 2229, 2232, 81 L.Ed.2d 59 (1984). "[A] complaint should not be dismissed for failure to state a claim unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 102, 2 L.Ed.2d 80 (1957). "Whether the district court correctly dismissed [the plaintiff's] claims pursuant to Fed.R.Civ.P. 12(b)(6) is a question of law subject to de novo review." Dugan v. Brooks, 818 F.2d 513, 516 (6th Cir.1987).
"Churning" is a shorthand expression for a type of fraudulent conduct in a broker-customer relationship where the broker "overtrades" a relying customer's account to generate inflated sales commissions. Armstrong v. McAlpin, 699 F.2d 79, 90 (2d Cir.1983).
Churning consists of three elements, all of which must be present: (1) the trading must be excessive in light of the customer's investment objectives; (2) the broker must exercise control over the account; (3) the broker must act with intent to defraud or with willful and reckless disregard of the customer's interests.
M & B Contracting Corp. v. Dale, 795 F.2d 531, 533 (6th Cir.1986).
Because an allegation of churning is an allegation of fraud, it must be pleaded with particularity; generalized and conclusory allegations that the defendants' conduct was fraudulent do not satisfy Rule 9(b). Armstrong, 699 F.2d at 88; Decker v....
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