Gruber v. Prudential-Bache Securities, Inc.

• Court: U.S. District Court — District of Connecticut
• Writing for the Court: Richard Blumenthal, Silver, Golub & Sandak, Stamford, Conn., for defendant James L. Condron
• Citation: Gruber v. Prudential-Bache Securities, Inc., 679 F.Supp. 165 (D. Conn. 1987)
• Decision Date: 31 December 1987
• Docket Number: Civ. No. B-86-317(JAC).
• Parties: Lucy GRUBER v. PRUDENTIAL-BACHE SECURITIES, INC., James L. Condron and Jerome N. King.

679 F. Supp. 165

Lucy GRUBER v. PRUDENTIAL-BACHE SECURITIES, INC., James L. Condron and Jerome N. King.

Civ. No. B-86-317(JAC).

United States District Court, D. Connecticut.

December 31, 1987.

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

J. Daniel Sagarin, William B. Barnes, Hurwitz & Sagarin, Milford, Conn., Mordecai Rosenfeld, Ira Capsuto, New York City, for plaintiff.

Linda L. Randell, Wiggin & Dana, New Haven, Conn., for defendant Prudential-Bache Securities, Inc.

Richard Blumenthal, Silver, Golub & Sandak, Stamford, Conn., for defendant James L. Condron.

Thomas D. Clifford, Skelley Clifford Vinkels Williams & Rottner, Hartford, Conn., for defendant Jerome N. King.

RULING ON MOTIONS TO DISMISS

JOSÉ A. CABRANES, District Judge:

This action arises out of an allegedly fraudulent scheme involving several Connecticut limited partnerships. Plaintiff brings this suit pursuant to the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. §§ 1962(c) and (d) (1982 & Supp. III 1985); §§ 10(b) and 20(a) of the Securities Exchange Act of 1934 (the "Act"), 15 U.S.C. §§ 78j(b), 78t(a) (1985); Rule 10b-5 of the Securities and Exchange Commission ("Rule 10b-5"), 17 C.F.R. § 240.10b-5 (1987); the Connecticut Uniform Securities Act, Conn.Gen.Stat. §§ 36-472, 36-498(a)(2); and state common law. The defendants are Prudential-Bache Securities, Inc. ("Prudential-Bache"), a registered broker-dealer; James L. Condron, chief executive officer and sole owner of J.L. Condron & Co.; and Jerome N. King, a certified public accountant.

On December 12, 1986, the court granted defendants' motions to dismiss the original complaint under Rule 9(b) of the Federal Rules of Civil Procedure for failure to plead fraud with the requisite particularity. In accordance with the court's ruling, plaintiff served an Amended Complaint (filed March 6, 1987) ("Complaint"). Pending before the court are defendants' motions to dismiss this Complaint for continued failure to comply with Fed.R.Civ.P. 9(b) and for failure to state a claim upon which relief may be granted, Fed.R.Civ.P. 12(b)(6). Also pending is plaintiff's motion for class action certification pursuant to Fed.R.Civ.P. 23(b)(3).

BACKGROUND

The facts alleged in the Complaint may be briefly summarized.¹ At some time prior to September 30, 1982, plaintiff Lucy Gruber telephoned Raymond O. Rose at the Prudential-Bache branch office in Stamford, Connecticut. At the time, Rose was employed by Prudential-Bache as a registered representative.² Rose advised plaintiff that she would be mailed an Offering Memorandum of Arrow Associates, a Connecticut limited partnership, and urged her to invest. He stated that, if necessary, Prudential-Bache would be able to transfer funds from her account with Merrill Lynch to its facilities. On or about October 4, 1982, plaintiff received through the mail the Offering Memorandum of Arrow Associates and two Prudential-Bache forms designated "Member Firm Authority to Transfer and Receive Account" and "Letter of Authorization to Transfer Securities or Monies between Accounts." Plaintiff immediately executed and returned the forms to the Prudential-Bache office in Stamford, and on or about October 8, 1982 she endorsed and mailed a Merrill Lynch check in the amount of $11,700.08 to the Prudential-Bache office. On or about October 18, 1982, plaintiff wrote a personal check in the amount of $8,299.92, which she mailed to the same address, bringing her entire initial investment up to $20,000. This second check was endorsed by Prudential-Bache.

The Complaint alleges that Arrow Associates was one of five interrelated limited partnerships created by Rose and defendant Condron (the "Partnerships").³ Interests in the Partnerships were sold to the public with the representation that the business of the Partnerships was investment in publicly traded securities. The Complaint alleges that these Partnerships were created as part of a scheme devised by Condron and Rose to defraud investors. Central to this scheme was the relationship between the Partnerships and Prudential-Bache. From March 1982 to April 1983, Condron advised and managed the Partnerships from his office located at the Prudential-Bache branch office in Stamford.⁴ Any checks sent by investors to the Partnerships were endorsed by Prudential-Bache, and any security transactions related to investment in the Partnerships were handled by Prudential-Bache. The Offering Memoranda for the Partnerships (the "Offering Memoranda") were distributed by Prudential-Bache from its Stamford office, and the telephone number for the Partnerships was that of Prudential-Bache.

From March 1982 to April 1983, Rose was employed by Prudential-Bache as a registered representative. He was assigned by James H. Hosp, a vice president in charge of Prudential-Bache's office in Darien, Connecticut, to work with Condron and the J.L. Condron & Co. account at the Prudential-Bache office in Stamford. In accordance with this assignment, Rose and Condron together sought investors in the Partnerships from the Prudential-Bache office. Investors in the Partnerships were also solicited by Hosp and two other registered Prudential-Bache representatives, Cheryl Coudert and Frank Romig, from the Prudential-Bache office in Darien. In return for these solicitations by Prudential-Bache personnel, Condron agreed to channel a substantial part of the Partnerships' business to Prudential-Bache on a commission basis. These commissions were expected to result in substantial financial gain for Prudential-Bache and its employees.

The Complaint first alleges fraudulent misrepresentations in the Offering Memoranda. The Offering Memoranda stated that no compensation would be paid to either Condron or his companies in connection with the sale of Partnership interests, or to any broker-dealer for placing and directing the sale of such interests, although, it is asserted, such compensation was indeed paid. In addition, the Offering Memoranda omitted certain material facts, including the fact that Partnership assets would be illegally commingled and transferred among the Partnerships, and the fact that anticipated brokerage commissions, management fees and interest on margin accounts would be greater than yearly investments.

The Complaint further alleges fraud in the management of the Partnerships. In addition to the commingling of assets and the payment of extraordinarily high commissions to brokerage firms, the management routinely violated legal margin requirements for the partnership accounts to cover debts and margin calls. Further, it is alleged that Condron and Rose improperly "churned" the accounts so as to increase their own fees. The Complaint sets forth an extensive list of fraudulent activities engaged in by both Condron and Rose in connection with the Partnerships, all in an effort to increase their profits in the form of higher commissions and fees from the Partnership accounts.

Finally, the Complaint alleges fraud on the part of defendant King with respect to the concealment of these activities. King, a certified public accountant, prepared the financial reports and tax statements mailed to the investors of the Partnerships for the fiscal year 1983. It is claimed that in preparing these reports and tax statements, King knowingly overstated the value of the Partnerships' assets and falsely reported their financial well-being.

Plaintiff contends that as a result of the fraudulent practices of defendants, the entire $3,700,000 invested by the public in the Partnerships was lost. Having withdrawn $4,947.21 from her investment in Arrow Associates on or about November 30, 1984, plaintiff brings this action seeking damages in the amount of her total net investment of $15,052.79. She also seeks class certification pursuant to Fed.R.Civ.P. 23(b)(3) for a class consisting of all investors in the Partnerships.

DISCUSSION

Defendants move under Fed.R.Civ.P. 9(b) to dismiss the Complaint for failure to allege fraud with sufficient particularity. Defendants also move pursuant to Fed.R. Civ.P. 12(b)(6) to dismiss the Complaint for failure to state valid claims under Sections 10(b) and 20(a) of the Act, RICO, and state securities laws.⁵ Because the allegations of fraud underlie most of the claims in the Complaint,⁶ the court will address first the motion to dismiss for failure to comply with Rule 9(b).

1. Sufficiency of the Pleadings Under Fed.R.Civ.P. 9(b)

Fed.R.Civ.P. 9(b) requires that "in all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." This strict rule of pleading has developed in tension with the liberal pleading requirements of Fed.R.Civ.P. 8.⁷See Luce v. Edelstein, 802 F.2d 49, 54 (2d Cir.1986); Ross v. A.H. Robins Co., 607 F.2d 545, 557 (2d Cir.1979), cert. denied, 446 U.S. 946, 100 S.Ct. 2175, 65 L.Ed.2d 1140 (1980). Rule 9(b) requires particularity in averments of fraud in part to apprise defendants of the claims against them and in part because of the potential harm to a defendant's good will and reputation resulting from the mere allegation of fraud. See Ross, 607 F.2d at 557. In securities litigation, the rule has been strictly construed in order to protect defendants from ungrounded suits that otherwise would fall within the general norm established in Rule 8. These "strike suits" carry a high settlement value; a defendant may be forced to settle an ungrounded claim simply to avoid the greater expense of extensive discovery. See Billard v. Rockwell Int'l Corp., 683 F.2d 51, 57 (2d Cir.1982); Decker v. Massey-Ferguson, Ltd., 681 F.2d 111, 114 (2d Cir.1982); Ross, 607 F.2d at 557.

In recognition of these concerns, courts have required claims brought under Section 10(b) of the Act and Rule 10b-5 to comply with the particularity requirement of Rule 9(b). See Decker, 681 F.2d at 114; Ross, 607 F.2d at 557. Similarly, the predicate act allegations of a RICO ...