Manufacturers Hanover Trust Co. v. Smith Barney, Harris Upham & Co.

• Decision Date: 22 July 1991
• Docket Number: No. 90 Civ. 4274 (WCC).,90 Civ. 4274 (WCC).
• Citation: 770 F. Supp. 176
• Parties: MANUFACTURERS HANOVER TRUST COMPANY, Plaintiff, v. SMITH BARNEY, HARRIS UPHAM & CO. INCORPORATED, Tucker Anthony & R.L. Day, Inc., Randolph T. Caden, Grace Marie Caden, Thomas F. Brancato, individually and doing business as Mackey Investment Fund, and Robert Serio, Defendants.
• Court: U.S. District Court — Southern District of New York

770 F. Supp. 176

MANUFACTURERS HANOVER TRUST COMPANY, Plaintiff, v. SMITH BARNEY, HARRIS UPHAM & CO. INCORPORATED, Tucker Anthony & R.L. Day, Inc., Randolph T. Caden, Grace Marie Caden, Thomas F. Brancato, individually and doing business as Mackey Investment Fund, and Robert Serio, Defendants.

No. 90 Civ. 4274 (WCC).

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

July 22, 1991.

Robert M. Rosenblith, New York City (Robin J. Arzt, of counsel), for plaintiff Manufacturers Hanover Trust Co.

Hugh McGovern, Legal Dept., Smith Barney, Harris Upham & Co., Inc., New York City, for defendants Smith Barney and Robert Serio.

Lloyd S. Clareman, New York City, for defendant Tucker Anthony.

Lecci, Wolin & Wolin, Hicksville, N.Y., for defendants, Randolph T. Caden, Grace Marie Caden.

Thomas F. Brancato, pro se.

OPINION AND ORDER

WILLIAM C. CONNER, District Judge.

Manufacturers Hanover Trust Company ("MHT"), a stock transfer agent for various publicly traded issuers, seeks to recover under Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), Rule 10b-5 of the Securities Exchange Commission, 17 C.F.R. § 240.10b-5, and a variety of common law theories, losses it sustained as a result of the defalcations of the assistant manager of its stock transfer department, Thomas Brancato ("Brancato").

Defendants Smith Barney, Harris Upham & Co., Inc. ("Smith Barney"), Robert Serio ("Serio"), and Tucker Anthony, Inc. ("Tucker Anthony") move this Court for an order, pursuant to Rules 12(b)(1) and 12(b)(6) of the Federal Rules of Civil Procedure, dismissing the complaint on the grounds that (i) plaintiff has failed to state a claim under the federal securities laws against the moving defendants; and (ii) in the absence of federal question or diversity jurisdiction, the pendent state and common law claims against them should be dismissed without prejudice to plaintiff's right to pursue such non-federal claims in state court.

For the reasons set forth below defendants' motion is granted.

BACKGROUND

As a stock transfer agent, MHT is entrusted with the custody and care of publicly traded stock certificates, in transferable form, by the owners or depositors of such stock certificates. (Complaint ¶¶ 20-21, 28). Thomas Brancato was employed by MHT from 1974 to January, 1989. (Complaint ¶ 33). Brancato supervised MHT's stock transfer operations and had access to the books and records regarding those operations, and to the stock certificates held in safekeeping by MHT. (Complaint ¶ 34). MHT alleges that beginning in late 1987 and continuing through January 1989, Brancato embezzled numerous stock certificates which had been entrusted to MHT for safekeeping by MHT's client Depository Trust Company ("DTC"). (Complaint ¶ 45). MHT alleges that Brancato effected his scheme by cancelling stock certificates held in DTC's name and issuing new certificates at first in the names of his confederate Randolph Caden ("Caden") and Caden's wife, and later in the name of Brancato's Mackey Investment Fund ("Mackey"). Caden and his wife opened a brokerage account at Tucker Anthony in December 1987 and two accounts at Smith Barney in the fall of 1988. (Complaint ¶¶ 36, 40, 41). In December 1988, Brancato opened an additional brokerage account at Smith Barney under the Mackey name. (Complaint ¶ 42). The individual account executive for all these accounts was Robert Serio, who left Tucker Anthony and joined Smith Barney in the fall of 1988. (Complaint ¶ 37-39, 43). Brancato caused the reissued stock certificates to be delivered to and sold by Serio for the benefit of the aforementioned accounts. (Complaint ¶¶ 48-72).

MHT discovered Brancato's defalcations in January 1989, and settled with DTC, the owner of the stock stolen by Brancato, by replacing it at a cost in excess of one million dollars. DTC then assigned to MHT such rights as it has in this matter. (Complaint ¶¶ 91-93).

In April, 1989, Brancato pleaded guilty to three criminal counts of an information in United States v. Brancato, 89 Cr. 288 (JMW), in this Court. The offenses to which Brancato pleaded guilty included (i) theft, embezzlement, or misapplication of securities entrusted to the custody or care of a bank by a bank officer; (ii) making false entries in the books, reports or statements of a bank with intent to injure or defraud; and (iii) sale of forged securities with intent to deceive other persons and organizations, all in connection with the matters described herein. (Complaint ¶ 95).

In May, 1990, Caden pleaded guilty to one count of conspiracy in violation of 18 U.S.C. § 371, contained in a seventeencount indictment in United States v. Caden, 89 Cr. 790 (DNE), also in this Court. (Complaint ¶ 96).

MHT served its complaint on June 26, 1990 alleging a conspiracy by all defendants to violate Section 10(b) of the Exchange Act and Rule 10b-5 of the SEC; violations by Smith Barney, Tucker Anthony and Serio of New York Stock Exchange Rule 405, the "Know Your Customer" Rule; and defendants' common law fraud, aiding and abetting, conversion and negligence. (Complaint ¶ 16).

Neither Smith Barney nor Serio knew who Brancato was until he opened the Mackey account in December 1988 shortly before Brancato's illegal activity was discovered by MHT in January 1989. (Complaint ¶¶ 73-74, 91). MHT does not allege that the stock certificates delivered by Caden to Serio and Smith Barney were in any way irregular or that Serio or Smith Barney could have determined from the face of the certificates that they were stolen. Similarly, there is no allegation of any specific misrepresentations or omissions by defendants Smith Barney, Tucker Anthony and Serio. Rather, MHT contends that Serio and Smith Barney breached a duty to the "investment public" by not exercising due diligence to learn essential facts about the Cadens and Brancato and their securities transactions as required under the "Know Your Customer Rule," New York Stock Exchange Rule 405. (Complaint ¶¶ 16, 73-77, 97-119). MHT alleges that if Smith Barney and Serio had exercised due diligence to acquire this information, they would have discovered that the trades by the Cadens and Brancato were uncharacteristically large; that the assets of the Cadens and Brancato were too modest to support a credible belief that the securities sold in their accounts belonged to them; and that neither the Cadens nor Brancato had documentation or a verifiable explanation supporting their claims of rightful ownership of the securities. (Complaint ¶ 104-109). MHT then asserts that if defendants had used this knowledge and made the "appropriate inquiries" to MHT, they would have learned that the securities were stolen in time to prevent the losses. (Complaint, 113-116).

DISCUSSION

In order to prevail on a motion to dismiss, the moving party must demonstrate "beyond doubt that the non-moving party 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, 101-102, 2 L.Ed.2d 80 (1957); Dahlberg v. Becker, 748 F.2d 85, 88 (2d Cir.1984), cert. denied, 470 U.S. 1084, 105 S.Ct. 1845, 85 L.Ed.2d 144 (1985). A court must take the factual allegations of the non-moving party's pleadings as true and construe them in the light most favorable to that party. See Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 1686, 40 L.Ed.2d 90 (1974); Dwyer v. Regan, 777 F.2d 825, 828-829 (2d Cir.1985), reh'g denied, 793 F.2d 457 (2d Cir.1986).

The essential elements of a claim under Section 10(b) and Rule 10b-5 promulgated thereunder are (1) damage to plaintiff; (2) caused by reliance on defendant's misrepresentations or omissions of material facts, or on a scheme by defendant to defraud; (3) made with an intent to deceive, manipulate or defraud (scienter); (4) in connection with the purchase or sale of securities; and (5) furthered by defendant's use of the mails in any facility of a national securities exchange. Bochicchio v. Smith Barney, Harris Upham & Co., 647 F.Supp. 1426, 1429 (S.D.N.Y.1986).

Defendants' motion to dismiss relies upon two alleged deficiencies in MHT's complaint: (1) that neither MHT nor its assignor DTC has standing as a "seller" of securities to bring an action pursuant to Section 10(b) and Rule 10b-5, and (2) that the complaint does not allege any fraud "in connection with" the sale of the stock involved.

Only purchasers and sellers of securities have standing to bring a private cause of action under Section 10(b). Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 749, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975), reh. denied, 423 U.S. 884, 96 S.Ct. 157, 46 L.Ed.2d 114 (1975); Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir.) cert. denied, 343 U.S. 956, 72 S.Ct. 1051, 96 L.Ed. 1356 (1952). Pursuant to the statute, a purchase includes any contract to buy, purchase, or otherwise acquire. 15 U.S.C. § 78c(a)(13). Similarly, a sale includes any contract to sell or otherwise dispose of. Id. § 78c(a)(14).

DTC, a depository institution, was the owner of 100,000 shares of Long Island Lighting Company ("LILCO") stock which was included among the stock embezzled by Brancato. At the times of Brancato's fraudulent transfers of LILCO stock to Caden or Mackey, the stock was in the possession of MHT, as the stock transfer agent for LILCO, in a balance certificate account maintained by DTC. Shortly after MHT discovered the fraud, pursuant to MHT's agreement with DTC, MHT replaced the 100,000 shares of LILCO stock in DTC's account through open market purchases. Since MHT made DTC whole for the LILCO shares, DTC assigned its claim against all parties for the theft of the LILCO shares to MHT. Therefore, MHT alleges, it is a seller of stock within Section 10(b) and Rule 10b-5 because MHT (1) stands in the shoes of the defrauded owner of the stock, (2) was in possession of the stock as transfer agent when Brancato made misrepresentations in the form of false entries in MHT's books and records in order...