Eickhorst v. EF Hutton Group, Inc.

• Decision Date: 11 January 1990
• Docket Number: 88 Civ. 7473 (RJW).,No. 88 Civ. 3002 (RJW),88 Civ. 3002 (RJW)
• Citation: 763 F. Supp. 1196
• Parties: Charmaine S. EICKHORST, et al., Plaintiffs, v. The E.F. HUTTON GROUP, INC. and John P. Holmes, Defendants. Eileen WINEGARD, et al., Plaintiffs, v. The E.F. HUTTON GROUP, INC. and John P. Holmes, Defendants.
• Court: U.S. District Court — Southern District of New York

763 F. Supp. 1196

Charmaine S. EICKHORST, et al., Plaintiffs, v. The E.F. HUTTON GROUP, INC. and John P. Holmes, Defendants.

Eileen WINEGARD, et al., Plaintiffs, v. The E.F. HUTTON GROUP, INC. and John P. Holmes, Defendants.

Nos. 88 Civ. 3002 (RJW), 88 Civ. 7473 (RJW).

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

January 11, 1990.

COPYRIGHT MATERIAL OMITTED

Elizabeth M. Toll, Beigel & Sandler, Ltd., New York City, for plaintiffs.

Benito Romano, Willkie Farr & Gallagher, New York City, for defendant E.F. Hutton Group, Inc.

MEMORANDUM DECISION

ROBERT J. WARD, District Judge.

Defendant, the E.F. Hutton Group, Inc. ("Hutton"), has moved to dismiss the amended complaints against it in the above-captioned cases pursuant to Rules 9(b) and 12(b)(6), Fed.R.Civ.P.¹ Plaintiffs in the Eickhorst action have moved to further amend the complaint to add an additional plaintiff. For the reasons that follow, the motion to dismiss the amended complaints is granted in part and denied in part, and the motion to amend the complaint in the Eickhorst action is granted.

BACKGROUND

Plaintiffs consist of one hundred-eightyone (181) investors in the Eickhorst action and seventeen (17) investors in the Winegard action, all of whom purchased interests in American Completion Program 1983-3 ("ACP-1983-3"), an oil and gas limited partnership, during the last quarter of 1983. Amended Complaints at ¶ 4.² Hutton acted as a sales agent for the limited partnership, and plaintiffs allegedly purchased their interests in ACP-1983-3 "upon the specific recommendation and insistence" of Hutton. Amended Complaints at ¶ 4. Plaintiffs now claim that they were misled about the degree of risk involved with this investment by the Hutton account executives who sold them the interests and by the prospectus for the program. According to plaintiffs, the Hutton account executives and the prospectus falsely characterized the investment as low risk and failed adequately to disclose the extent of the risk involved and the true likelihood of plaintiffs ever realizing a profit on their investment. They contend that their interests in the limited partnership have become worthless, in part due to the worldwide decline in the price of oil which occurred after they invested in ACP-1983-3.

Plaintiffs argue that Hutton formulated a scheme to distribute high risk securities to its conservative customers. As part of that overall scheme, they maintain that Hutton management directed the marketing and sale of the ACP-1983-3 program as a low risk investment by supplying the account executives responsible for selling the partnership interests with material, including a sales memorandum called the "Blue Top," a brochure, and certain financial projections, which falsely portrayed ACP-1983-3 as a conservative investment. The misleading information was then passed along to plaintiffs through the recommendations of the account executives.

The original complaints in these actions named as defendants the American Completion and Development Corporation, ACP-1983-3 (collectively the "American Completion Defendants"), Howard W. Phillips ("Phillips"), John P. Holmes ("Holmes"), and Hutton. The complaints asserted claims against defendants under (1) Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b) and Rule 10b-5 promulgated thereunder by the Securities and Exchange Commission, 17 C.F.R. § 240.10b-5; (2) Section 17(a) of the Securities Act of 1933 (the "1933 Act"), 15 U.S.C. § 77q(a); (3) common law fraud; and (4) the Racketeer Influenced and Corrupt Organizations Act ("R.I.C.O."), 18 U.S.C. §§ 1962(a), (c) and (d).

This Court, in an Opinion filed on February 1, 1989, dismissed the claims under Section 17(a) of the 1933 Act, holding that Section 17(a) does not provide a private right of action.³ The remaining claims were dismissed for failure to plead fraud with particularity as required by Rule 9(b). Plaintiffs were granted leave to replead their fraud-based claims against defendants within the parameters set by Rules 9(b) and 11, Fed.R.Civ.P. Eickhorst I, 706 F.Supp. at 1102.

Subsequently, plaintiffs settled their claims with the American Completion Defendants and with Phillips. On March 31, 1989, plaintiffs filed amended complaints naming as defendants only Hutton and Holmes. Prior to the instant motions, plaintiffs settled their claims against Holmes. The amended complaints allege two Section 10b claims against Hutton, the first based upon the sale of unsuitable securities, the second based upon prospectus fraud.⁴ Plaintiffs also assert state law claims against Hutton based upon common law fraud and breach of fiduciary duty.

DISCUSSION

Rule 9(b) provides that:

In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other condition of mind may be averred generally.

As the Court explained in Eickhorst I, in a motion to dismiss a complaint for failure to plead fraud with particularity as required by Rule 9(b), plaintiffs' allegations must be taken as true. E.g., Luce v. Edelstein, 802 F.2d 49, 52 (2d Cir.1986). The court must read the complaint generously, and draw all inferences in favor of plaintiffs. Cosmas v. Hassett, 886 F.2d 8, 11 (2d Cir.1989). Furthermore, Rule 9(b) must be read in conjunction with Rule 8(a), Fed.R.Civ.P., which requires a plaintiff to plead only a short, plain statement of the grounds upon which he is entitled to relief. Ross v. A.H. Robins Co., 607 F.2d 545, 557 n. 20 (2d Cir.1979), cert. denied, 446 U.S. 946, 100 S.Ct. 2175, 64 L.Ed.2d 802 (1980). The serious nature of a charge of fraud, however, renders mere conclusory allegations that defendants acted fraudulently insufficient to satisfy Rule 9(b). Segal v. Gordon, 467 F.2d 602, 607 (2d Cir.1972); Center Savings & Loan Assoc. v. Prudential-Bache Securities, Inc., 679 F.Supp. 274, 276 (S.D.N.Y.1988).

Rule 9(b) is designed to provide a defendant with fair notice of a plaintiff's claim in order to enable the defendant to prepare a defense, to protect his or her reputation or goodwill from harm flowing from baseless allegations of fraud, and to reduce the number of strike suits. Cosmas v. Hassett, supra, 886 F.2d at 11; DiVittorio v. Equidyne Extractive Industries, Inc., 822 F.2d 1242, 1247 (2d Cir.1987). In order to satisfy Rule 9(b) "a complaint must adequately specify the statements it claims were false or misleading, give particulars as to the respect in which plaintiff contends the statements were fraudulent, state when and where the statements were made, and identify those responsible for the statements." Cosmas v. Hassett, supra, 886 F.2d at 11. See also Eickhorst I, 706 F.Supp. at 1091.

While Rule 9(b) allows "condition of mind" to be averred generally, plaintiffs must at least present those circumstances that provide a minimal factual basis for the allegations of scienter. E.g., Connecticut National Bank v. Fluor Corp., 808 F.2d 957, 962 (2d Cir.1987). In other words, plaintiffs must "`specifically plead those events' which `give rise to a strong inference' that defendants had an intent to defraud, knowledge of the falsity, or a reckless disregard for the truth." Id. at 962 (citing Ross v. A.H. Robins, supra, 607 F.2d at 558); Cosmas v. Hassett, supra, 886 F.2d at 12-13.

A. The Unsuitability Claim

A claim for fraud under Section 10(b) is stated by alleging that (1) an investment was unsuited to plaintiffs' needs; (2) the broker knew or reasonably believed the investment was unsuitable; yet (3) the broker recommended the investment anyway. See Clark v. John Lamula Investors, Inc., 583 F.2d 594, 600 (2d Cir.1978); Bischoff v. G.K. Scott & Co., Inc., 687 F.Supp. 746, 752 (E.D.N.Y.1986); Mauriber v. Shearson/American Express, Inc., 567 F.Supp. 1231, 1237 (S.D.N.Y.1983). The facts upon which an unsuitability claim is based, like those supporting other fraud claims, must be pleaded with adequate particularity to satisfy Rule 9(b). Clark v. Kidder, Peabody & Co., Inc., 636 F.Supp. 195, 199 (S.D.N.Y.1986).

Each plaintiff has alleged that he or she informed an account executive at Hutton of his or her relevant investment objective, usually being either "income" or "capital appreciation and preservation," and that he or she was informed by the account executive that the risk involved with ACP-1983-3 was either low or nonexistent prior to purchasing the interest. Amended Complaints at ¶ 4.

Plaintiffs argue that they were all conservative investors whose investment objective was to avoid risk, and that ACP-1983-3 was a high risk investment unsuitable to their needs. The specific allegations in the Amended Complaints concerning plaintiffs' investment objectives are meager, but, reading the pleadings generously as the Court must on this motion, they do indicate the reasons why the securities are asserted to be unsuitable as well as the specific transactions involved. See Bischoff v. G.K. Scott & Co., Inc., supra, 687 F.Supp. at 753 (complaint must indicate which securities were involved and why they are unsuitable).⁵

In addition, plaintiffs have alleged that Hutton management knew that ACP-1983-3 was not a low risk investment because: (1) the very nature of the investment subjected its profitability and liquidity to the whims of the world oil market, (2) the level of risk involved with the limited partnership was clear to anyone with a basic knowledge of oil and gas investments at the time Hutton recommended ACP-1983-3, and (3) Hutton was at least generally familiar with the level of these risks because it had investigated ACP-1983-3 prior to selling the interests and had participated in numerous other oil and gas partnerships. Amended Complaints at ¶ 28.⁶ These allegations differ from the scienter allegations of the previous complaint in that they focus on the risks associated with the sale of ACP-1983-3 at the time plaintiffs purchased their...