Crummere v. Smith Barney, Harris Upham & Co., Inc.

• Decision Date: 31 October 1985
• Docket Number: No. 85 Civ. 1376 (RWS).,85 Civ. 1376 (RWS).
• Citation: 624 F. Supp. 751
• Parties: Marie CRUMMERE, Plaintiff, v. SMITH BARNEY, HARRIS UPHAM & CO., INCORPORATED, Michael Q. Brown, Jackie Johnston, Merrill Lynch, Pierce, Fenner & Smith, Inc. and Frank Caverretta, Defendants.
• Court: U.S. District Court — Southern District of New York

624 F. Supp. 751

Marie CRUMMERE, Plaintiff, v. SMITH BARNEY, HARRIS UPHAM & CO., INCORPORATED, Michael Q. Brown, Jackie Johnston, Merrill Lynch, Pierce, Fenner & Smith, Inc. and Frank Caverretta, Defendants.

No. 85 Civ. 1376 (RWS).

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

October 31, 1985.

John P. Rudden, New York City, for plaintiff.

Bachner, Talley & Mantel, New York City (David E. Wolff, of counsel), for defendant Jackie Johnston.

Mandel, Weiner & Block, New York City (Phillip Mandel, of counsel), for defendant Merrill Lynch.

Henry Lukas, New York City, for defendant Smith Barney c/o Smith Barney, Harris Upham & Co., Inc.

Cletus P. Lyman, Philadelphia, Pa., for defendant Michael Q. Brown.

OPINION

SWEET, District Judge.

Now pending in this securities case are motions on behalf of the individual defendants Michael Brown ("Brown") pro se, Frank Caverretta ("Caverretta"), Jackie Johnston ("Johnston"), and the two securities firm defendants, Smith Barney, Harris Upham & Co., Inc. ("Smith Barney") and Merrill Lynch, Pierce, Fenner & Smith, Inc. ("Merrill Lynch"), to dismiss the amended complaint of plaintiff Marie Crummere ("Crummere") for lack of federal subject matter jurisdiction, failure to state a claim upon which relief can be granted, and for failure to plead fraud with particularity, Federal Rules of Civil Procedure, Rules 12(b)(1), 12(b)(6) and 9(b) respectively. The motion is granted for the reasons set forth below.

Prior Proceedings

Crummere's initial complaint, filed on February 20, 1985, contained only one claim against defendants Smith Barney, Brown and Johnston which is identical to the first claim of the amended complaint discussed below. On May 24, 1985, Crummere amended her complaint pursuant to leave of this court, adding a second claim against Merrill Lynch and Caverretta and a third claim against Chemical Bank which was dismissed for lack of federal jurisdiction over the defendant. In response to this amended complaint, all defendants filed this motion to dismiss the complaint of July 14, 1985, and one month later Crummere filed a motion for partial summary judgment against defendant Brown on the state law claim. In addition, Crummere has sought leave to amend her amended complaint to add a claim under 18 U.S.C. §§ 1961 et seq. (RICO).

Facts

In determining the validity of a motion to dismiss, the court assumes and sets forth below the facts contained in Crummere's amended complaint. SEC v. Drysdale Securities Corp., 606 F.Supp. 295 (S.D.N.Y. 1985); Miree v. DeKalb, 433 U.S. 25, 97 S.Ct. 2490, 53 L.Ed.2d 557 (1977).

The complaint charges that the defendants Brown, Johnston, and Caverretta, with the aid of the corporate defendants Smith Barney and Merrill Lynch, defrauded her in violation of the federal securities laws and state laws under the following alleged facts.

In August of 1983, Crummere was approached by Brown who persuaded her to give him $61,000 in cash over the next four months to invest on her behalf with Smith Barney, the brokerage firm which was employing Brown as a registered representative. Five thousand dollars of this initial sum came from the cashing of Long Island Lighting Company ("LILCO") bonds owned by the plaintiff. Instead of investing this money for Crummere in her Smith Barney account, Brown diverted it to an account maintained at Merrill Lynch in the name of his sister, Jackie Johnston, an account managed by Caverretta as registered representative employed by Merrill Lynch. This Johnston account was controlled by Brown who had discretionary authority over the account. Crummere never received any documentation regarding the investments Brown was purportedly making on her behalf, despite her efforts to verify the safety of her savings.

The misappropriation of funds continued throughout the fall of 1984, when Brown persuaded Crummere to cash $154,000 worth of bonds which she had entrusted to him in her account. She received two checks (totaling $154,000) from Smith Barney as proceeds of these bonds and deposited them in her personal checking account at Chemical Bank. One day later, Crummere turned these proceeds over to Brown for investment in her Smith Barney account by drawing personal checks from her Chemical Bank account. When Crummere received the cancelled checks, she discovered that they never had been deposited in her account, that Smith Barney as payee had been replaced with the word "cash", and that they were deposited instead in Brown's personal checking account at Chemical Bank. These funds eventually were transferred to Johnston's account at Merrill Lynch. When Crummere confronted Brown with these cancelled checks in October of 1985, Brown gave her four promissory notes totaling $220,500. Apparently not comforted by the tender of these notes, Crummere telephoned Brown's branch manager at Smith Barney to complain of Brown's alleged fraud. The supervisor never returned her call, and Crummere later contacted another Smith Barney representative to complain that Brown had defrauded her.

The plaintiff bases three claims on these circuitous diversions of her funds. The first claim is that Brown, Johnston and Smith Barney conspired to misappropriate funds and to divert them into the Merrill Lynch account under Johnston's name, violating section 10(b) of the Securities Exchange Act of 1934 (the "1934 Act"), 15 U.S.C. section 78j(b), and sections 12 or 17 of the Securities Act of 1933 (the "Securities Act"), 15 U.S.C. §§ 77l and 77q.¹ Crummere also alleges two pendent state claims related to this first claim, one based on Brown's tender of the four promissory notes, and the other based on Smith Barney's allegedly negligent hiring and supervision of Brown.

Crummere's second cause of action centers around the activities of Brown and Caverretta in the administration of Johnston's brokerage account with Merrill Lynch. Crummere contends that Brown, Caverretta and Merrill Lynch conspired to defraud her by diverting money from her Smith Barney account, placing the money in the Merrill Lynch account under Brown's actual control, and "engaging in speculative, inappropriate churning" of the securities. The claim further alleges that Merrill Lynch knew or should have known that such activities were improper and unlawful and that Merrill Lynch negligently supervised the activities of Caverretta with regard to the account.

The final claim charged that Chemical Bank improperly honored the two checks altered by Brown in violation of the Uniform Commercial Code and applicable duties under common law of negligence and warranty. Chemical Bank was, however, dismissed as a defendant on August 19, 1985 for lack of federal jurisdiction.

Discussion

Crummere's amended complaint fails to establish grounds for the exercise of federal jurisdiction over her claim. In order to state a claim under the fraud provisions of the Securities Act or the 1934 Act, the fraud must have been accomplished through the purchase or sale of a security. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975) (A private damage action under Rule 10b-5 is confined to actual purchasers and sellers of securities); Birnbaum v. Newport Steel, 193 F.2d 461 (2d Cir.1952); Parness v. Lieblich, 489 F.Supp. 889, 892 (S.D.N.Y.1980) (A plaintiff who is not a purchaser of securities may not maintain a cause of action under Section 17(a) of the Securities Act).

Under both the Securities Act and the 1934 Act, isolated sales or purchases will not satisfy this standing requirement. To state a claim under Rule 10b-5 of the Exchange Act, Crummere must show (1) the defendants misrepresented or omitted to state material facts in connection with the purchase or sale of a security; (2) that she relied to her detriment upon defendants' misrepresentations and omissions; and (3) defendants made their misrepresentations or omissions with scienter. Savino v. E.F. Hutton & Co., Inc., 507 F.Supp. 1225, 1231 (S.D.N.Y.1981). Section 17(a) of the Securities Act requires the same stringent connection between the fraud and the security transaction. Plaintiffs must show that the fraud, misstatement or omission occurred "in the offer or sale of any securities." Chemical Bank v. Arthur Anderson & Co., 726 F.2d 930, 945 (2d Cir.1984) (The standard for connection imposed by 17(a) of the Securities Act is at least as high as that of 10(b) and Rule 10b-5).

Crummere alleges that three groupings of transactions meet this purchase and sale requirement: the initial sale of LILCO bonds, the sale of $154,000 of miscellaneous bonds, and the "churning" of securities in Jackie Johnston's Merrill Lynch account. These security transactions were so removed from the alleged conversion of Crummere's funds, that they fail to constitute transactions "in connection" with the fraud.

Crummere admits in her complaint that the initial sale of LILCO bonds to open her Smith Barney account proceeded without incident (Par. 12) and that the bonds were sold for full value with no detrimental reliance on any representations made by Brown. The $154,000 of miscellaneous bonds were cashed by Smith Barney in accordance with Crummere's instructions, and Smith Barney sent checks to her home which she deposited in her personal checking account at Chemical Bank. While Brown later convinced Crummere to turn over the proceeds of this sale to him for investments which he never made on her behalf, the mere fact that the funds originated from a bond sale does not connect them to a later conversion of those funds. To satisfy the purchase and sale requirements of rule 10b-5, there must be a causal connection between the misstatements or omissions and the plaintiff's purchases or sales, and there can be no such connection where the misstatement occurs after the purchase. Troyer v. Karcagi, 476 F.Supp. 1142, 1148 (S.D.N.Y.1979). Here, Brown's alleged misstatements occurred after the unremarkable sale of Crummere's bonds, when he...