Leonard v. Shearson Lehman/American Exp. Inc.

• Decision Date: 16 May 1988
• Docket Number: Civ. A. No. 86-5808.
• Citation: 687 F. Supp. 177
• Parties: Herbert W. LEONARD v. SHEARSON LEHMAN/AMERICAN EXPRESS INC., et al.
• Court: U.S. District Court — Eastern District of Pennsylvania

687 F. Supp. 177

Herbert W. LEONARD v. SHEARSON LEHMAN/AMERICAN EXPRESS INC., et al.

Civ. A. No. 86-5808.

United States District Court, E.D. Pennsylvania.

May 16, 1988.

Edward Fackenthal, Henderson Wetherill O'Hey & Horsey, Norristown, Pa., for plaintiff.

C. Clark Hodgson, Jr., David C. Franceski, Jr., Stradley Ronon Stevens & Young, Philadelphia, Pa., Keith R. Dutill, for Shearson Lehman Brothers, Inc. and Peter Von Nessi, Jr.

Howard B. Arber, Hempstead, N.Y., for James F. Brennan & Joseph Ferrari.

MEMORANDUM

GILES, District Judge.

Herbert W. Leonard has filed suit complaining that a representative of Shearson Lehman/American Express (Shearson Lehman) in its Harrisburg, Pennsylvania branch, and several officers of that firm located in New York City, made material misrepresentations to him upon which he relied.¹ Plaintiff claims that as a result of these misrepresentations he lost $125,000.

These losses were allegedly incurred as a result of plaintiff's participation in an options trading program, entitled "The S & P 100 Index Income Strategy" (the "Strategy"). See Complaint, Ex. A. Plaintiff maintained this securities account with defendants between April, 1984 and September, 1986.

Plaintiff alleges that defendants made false representations regarding the Strategy in violation of: Sections 12 and 17 of the Securities Act of 1933, 15 U.S.C. §§ 77l, 77q; the Commodity Exchange Act, 7 U.S. C. § 1, et seq.; the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. § 1961 et seq.; Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, and the Pennsylvania Securites Act of 1972, Pa.Stat.Ann., tit. 70, § 1-401 (Purdon 1985). Plaintiff also alleges the common law actions of breach of contract, fraud, breach of fiduciary duty, and negligence.

On November 26, 1986, defendants moved to sever and compel arbitration of plaintiff's state law claims, stay plaintiff's Section 10(b) and Rule 10b-5 claims, and dismiss plaintiff's Securities Act of 1933 claims, Commodity Exchange Act claim, and RICO claim. This court granted defendants' motion on December 19, 1986. On January 2, 1987, plaintiff moved for reconsideration of this court's order. On October 5, 1987, the stay was lifted on the Section 10(b) and Rule 10b-5 claims.

Upon reconsideration of the other claims, I hold that the Securities Act of 1933 claims and the RICO claim were properly dismissed with prejudice. The state-law claims were also properly sent to arbitration. The Commodity Exchange Act may not have been properly dismissed due to a possible fact dispute and the order dismissing that claim will be vacated accordingly.

I. SECURITIES ACT OF 1933

Count I of the complaint alleges violations of both Sections 12 and 17 of the Securities Act of 1933. As a matter of law, plaintiff cannot advance either of these claims against defendants.

a. Section 12

Section 12 provides:

Any person who ... (2) offers or sells a security ... by the use of any means or instruments of transportation or communication in interstate commerce ... which includes an untrue statement of material fact or omits to state a material fact necessary in order to make the statements ... not misleading, shall be liable to the person purchasing such security from him....

15 U.S.C. § 77l(2) (emphasis added).

The third circuit has held that Section 12 is designed solely as a vehicle for a purchaser against his immediate seller. Collins v. Signetics Corp., 605 F.2d 110, 113 (3d Cir.1979). Absent allegations of strict privity between the plaintiff and defendants, or allegations that defendants had control over the seller, plaintiff has no cause of action under Section 12. See also Kramer v. Scientific Control Corp., 452 F.Supp. 812, 814 (E.D.Pa.1978).

Plaintiff first contends that a broker is a seller under Section 12(2). I disagree. Plaintiff cites no case law to support his position. In addition, the argument lacks common sense. A broker fields the offers of sellers or purchases stock or options from a seller on behalf of a client. A broker also offers advice to or, if authorized, makes decisions on behalf of a client. To argue that defendants, in their role as brokers, "sold" or "offered" securities to the plaintiff within the meaning of Section 12(2) ignores this basic definition of a broker and is an implausible interpretation of the statute.

Defendants correctly argue that Section 12(2) simply is not intended to remedy a principal-agent dispute such as the one at hand. The statute is intended to redress prospectus or registration statement fraud in a buyer/seller relationship in an initial offering transaction. Defendants aptly observe that plaintiff's "dispute is with the functioning of the options writing strategy, a claim which cannot be brought within, or remedied by, Section 12(2) of the Securities Act." Defendants' Memorandum in Opposition to Motion to Amend or Alter Judgment at 7-8.

Plaintiff next argues that defendants were the seller by reason of their contractual relation between the issuer of the options and the purchaser. Plaintiff states that defendants were "clearing members" or "de facto underwriters" and that this status makes them liable under Section 12(2). An examination of the program literature attached to plaintiff's complaint shows that plaintiff wrote and sold options in return for a premium. See Complaint, Ex. A. Plaintiff alleges that Shearson then "closed or otherwise disposed of the puts, calls and straddles which it purchased for and managed in Shearson's account for Leonard." Amended Complaint, ¶ 20 (emphasis added). Shearson was not a seller or a purchaser. As plaintiff's broker, it made purchases and sales for plaintiff's account. As discussed above, a broker is not liable under Section 12(2).

Finally, plaintiff argues that defendants are liable under Section 12(2) for their substantial aid and participation in the sale to Leonard. As discussed above, the third circuit has held that absent privity between the seller and buyer, or some special relationship, such as control over the seller, plaintiff cannot maintain an action under Section 12(2). Collins, 605 F.2d at 113. Plaintiff has not alleged that defendants had any control over the seller other than those activities which a broker traditionally performs.

Plaintiff cites a fifth circuit case which held that a broker not passing title to a security can, nevertheless, be a seller for Section 12(2) purposes if the injury to the purchaser flowed directly and proximately from actions of the broker. See Hill York Corp. v. American International Franchises, Inc., 448 F.2d 680 (5th Cir.1971). The fifth circuit has, however, rejected the strict privity requirements which comprise the law of this circuit. I am not free to move from the third circuit's strict privity requirements towards a standard of "substantial participation."

b. Section 17

The third circuit has not yet addressed the issue, but this court has previously held that a private right of action cannot be implied under Section 17(a).² See In re Catanella and E.F. Hutton and Co., 583 F.Supp. 1388, 1419 (E.D.Pa.1984); Kimmel v. Peterson, 565 F.Supp. 476, 483 (E.D.Pa.1983); Mursau Corp. v. Florida Penn Oil & Gas, Inc., 638 F.Supp. 259, 261 (W.D.Pa.1986).

As stated in Kimmel, Section 17(a) fails at least two prongs of the four prong test designed to devine Congressional intent under the teaching of Cort v. Ash, 422 U.S. 66, 95 S.Ct. 2080, 45 L.Ed.2d 26 (1975). An implied private right of action under Section 17(a) would be inconsistent with the other sections of the Act and its legislative history, and with other federal securities laws, such as Section 10(b) of the Securities Exchange Act of 1934. In particular, Kimmel noted that a private right of action under Section 17(a) would allow plaintiffs to pursue Section 10(b) claims under Section 17(a) and avoid the scienter requirements of Section 10(b). In addition, use of Section 17(a) would overlap Sections 11 and 12 of the 1933 Act and effectively write them out of the statute. Kimmel, 656 F.Supp. at 487.

For these reasons, I hold that Section 17(a) does not provide for a private right of action.

II. COMMODITIES EXCHANGE ACT

Plaintiff's claim under the Commodities Exchange Act was dismissed because it appeared that the complaint did not allege the trading of any commodities, as required under the act. See Complaint, Ex. A. The Commodities Exchange Act covers only transactions involving commodities, such as wheat, cotton, rice, corn, oats, etc. 7 U.S.C. Section 2.

However, now plaintiff asserts that the claim should not have been dismissed because the defendants may have been speculating in "stock index futures", which may have been designated as commodities, rather than "stock index options," which, in turn, may have been designated securities. 7 U.S.C. Section 2a. Plaintiff alleges that the "puts, calls and straddles Shearson sold Leonard and wrote for his account were contracts of sale for future delivery of broad-based stock indices constituting stock index futures." Amended Complaint, ¶ 26. Defendants counter that plaintiff has not plead facts sufficient to bring his claim within the statutory requirements of the Commodities Exchange Act.

However, plaintiff's allegations do raise the issue of whether index futures were traded. An issue of material fact exists and the claim cannot be dismissed on this record. See 7 U.S.C. Section 2a. Accordingly, plaintiff's motion for reconsideration is granted, and that part of the order of December 19, 1986 dismissing Count III with prejudice is vacated.

III. RICO

Plaintiff's amended complaint does not specify whether plaintiff brings his RICO claim under Section 1962(a), 1962(b), or 1962(c). Therefore, the court must consider all of the possible claims.

a. Section 1962(a)

Section 1962(a) provides:

(a) It shall be unlawful for any person who has received any income

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