Sullivan v. Chase Inv. Services of Boston, Inc., C-76-1783-CBR.

Citation434 F. Supp. 171
Decision Date25 March 1977
Docket NumberNo. C-76-1783-CBR.,C-76-1783-CBR.
CourtUnited States District Courts. 9th Circuit. United States District Courts. 9th Circuit. Northern District of California
PartiesMary W. SULLIVAN et al., Plaintiffs, v. CHASE INVESTMENT SERVICES OF BOSTON, INC., a corporation, et al., Defendants.

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Anthony P. David, John Bilyeu Oakley, San Francisco, Cal., for plaintiffs.

Steinhart, Goldberg, Feigenbaum & Ladar, Marvin D. Morgenstein, John Curran Ladd, Eliot S. Jubelirer, San Francisco, Cal., for defendants Chase Investment Services of Boston, Inc.; Phoenix Investment Counsel of Boston, Inc.; Virginia Spencer; Frederick G. Thorne; John P. Chase; Richard A. Spindler.

Dinkelspiel & Dinkelspiel, Bruce W. Belding, San Francisco, Cal., for defendants E. F. Hutton & Company, Inc., and Thomas William Mitchum, Jones and Templeton, Inc., and Harold Harris.

Severson, Werson, Berke & Melchior, Robert L. Lofts, D. Ronald Ryland, San Francisco, Cal., for defendants Monte J. Wallace and Neil W. Wallace.

Arnold & Porter, Richard J. Wertheimer, Paul S. Ryerson, Washington, D.C., McKenna & Fitting, Paul Fitting, Charles G. Miller, San Francisco, Cal., for defendants Sullivan and Worcester, John Hand, and Thomas R. B. Wardell.

Sullivan, Jones & Archer, Richard J. Archer, Lee J. Sclar, San Francisco, Cal., for defendants Dean Witter & Co., Incorporated, and John Gates.

MEMORANDUM OF OPINION

RENFREW, District Judge.

This is an action against Chase Investment Services of Boston, Inc. ("CIS"), and 27 other defendants, seeking to recover damages for the publishing of allegedly fraudulent and deceptive promotional materials ("brochures") and the making of certain other deceitful statements describing the investment advisory services offered by CIS. Plaintiffs alleged that these misstatements were willfully made with the purpose and result of influencing plaintiffs to employ the services of CIS. Plaintiffs contend that, in addition to various state law violations, defendants have violated the Securities Exchange Act of 1934, 15 U.S.C. §§ 78a et seq. ("Exchange Act"), the Investment Advisers Act of 1940, 15 U.S.C. §§ 80b-1 et seq., and the rules and regulations promulgated under the two federal laws.

Plaintiffs, former customers of CIS, seek to represent the class of all "persons who entered into agreements for investment advisory services with defendant CIS during the period from April 1, 1971, to and including May 31, 1973." In addition to CIS, the other defendants consist of two corporations and fourteen individuals alleged to have directly or indirectly "controlled and dominated" the activities of CIS, two employees of CIS, a law firm and two of its attorneys who were legal advisors to CIS, and three individual stockbrokers and their respective employer brokerage houses.

Defendants Monte J. Wallace, Neil W. Wallace, Sullivan & Worcester, John Hand and Thomas R. B. Wardell (hereinafter referred to as "defendants") have moved to dismiss the complaint pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. Defendants Monte J. Wallace and Neil W. Wallace are each controlling persons of a parent corporation of CIS1 and are alleged to have "dominated, controlled, influenced and governed" the activities of CIS at all times relevant to this action. Defendant Sullivan & Worcester is a partnership of attorneys organized and existing under the laws of Massachusetts. Defendants Hand and Wardell are a partner and an associate, respectively, of Sullivan & Worcester and were legal advisors to CIS in the drafting of the promotional materials at issue in this case.

Defendants argue in support of their motion to dismiss that any misconduct which might have taken place in the description of the services or past performance of CIS does not constitute fraudulent or deceitful conduct "in connection with the purchase or sale of any security," as prohibited by § 10(b) of the Exchange Act or Rule 10b-5. Defendants further argue that plaintiffs may not bring a private damage action pursuant to the Investment Advisers Act of 1940 against anyone who is not, himself, an investment advisor.2

I. SECURITIES EXCHANGE ACT OF 1934

Section 10(b) of the Exchange Act forbids the use of any manipulative or deceptive device "in connection with the purchase or sale of any security * * *." 15 U.S.C. § 78j(b). Rule 10b-5 similarly prohibits the employment of "any device, scheme, or artifice to defraud * * * in connection with the purchase or sale of any security." 17 C.F.R. § 240.10b-5.

The applicability of the Securities Exchange Act of 1934 to the sale of investment advisory services is far from clear. Indeed, six years after the Exchange Act became law, Congress enacted the Investment Advisers Act of 1940 because "virtually no limitations or restrictions exist with respect to the honesty and integrity of individuals who may solicit funds to be controlled, managed, and supervised." S.Rep. No. 1775, 76th Cong., 3d Sess. 21 (1940).

Plaintiffs' contention that investment advisory services are securities within the meaning of the Exchange Act is unpersuasive. "Security" is defined in § 3 of the Exchange Act.3 15 U.S.C. § 78c(a)(10). Congress intended the definition to be broad and general but to encompass the "types of instruments that in our commercial world fall within the ordinary concept of a security." United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 847-848, 95 S.Ct. 2051, 2058, 44 L.Ed.2d 621 (1975), quoting H.R.Rep. No. 85, 73d Cong., 1st Sess. 11 (1933).4

The only term in § 3 of the Exchange Act under which the sale of advisory services might conceivably fall is that of "investment contract." Although Congress intended the definition of investment contract to be flexible, S.E.C. v. Howey Co., 328 U.S. 293, 299, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946), the term is not all-encompassing. "`The test for an investment contract is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.'" Tcherepnin v. Knight, 389 U.S. 332, 338, 88 S.Ct. 548, 554, 19 L.Ed.2d 564 (1967), quoting S.E.C. v. Howey Co., supra, 328 U.S. at 301, 66 S.Ct. 1100.

The Court found an investment contract to exist in Howey, because the defendants were "offering an opportunity to contribute money and to share in the profits of a large citrus fruit enterprise managed and partly owned by the defendants." S.E.C. v. Howey Co, supra, 328 U.S. at 299, 66 S.Ct. at 1103. A similar result was warranted in Tcherepnin, because plaintiffs were

"participants in a common enterprise — a money-lending operation dependent for its success upon the skill and efforts of the management of City Savings Association of Chicago in making sound loans. * * * The petitioners could expect a return on their investment only if City Savings showed a profit." 389 U.S. at 338-339, 88 S.Ct. at 554.

In the instant case plaintiffs did not, in effect, buy shares of CIS; their individual fortunes did not ride on the overall success or failure of CIS. Instead, each plaintiff subscribed to the investment service of CIS. The profits depended on the ultimate success or failure of the particular investments made on plaintiffs' behalf by a stockbroker.

The purchase of investment advice does not constitute investment in a common enterprise but rather is, at most, use of a common agent. The case at bar closely resembles the facts in Milnarik v. M-S Commodities, Inc., 457 F.2d 274 (7 Cir.), cert. denied, 409 U.S. 887, 93 S.Ct. 113, 34 L.Ed.2d 144 (1972). In that case the Court of Appeals for the Seventh Circuit, per Stevens, J., held that an individual who, for a fee, invested clients' money in the commodities market was not selling a security within the meaning of the Securities Act of 1933. 15 U.S.C. § 77b(1). The court found that even though the defendant invested the money at his own discretion, the element of commonality necessary to constitute an investment contract was missing:

"Although the complaint does allege that Nelson entered into similar discretionary arrangements with other customers, the success or failure of those other contracts had no direct impact on the profitability of plaintiffs' contract. Nelson's various customers were represented by a common agent, but they were not joint participants in the same investment enterprise." 457 F.2d at 276-277.

Accord, Stuckey v. duPont Glore Forgan Incorporated, 59 F.R.D. 129, 131-132 (N.D. Cal.1973).

Plaintiffs argue in the alternative that even if investment advisory services are not a security, fraud in the sale of such services qualifies as fraud in connection with the purchase or sale of other securities. This argument has already been rejected in the Northern District of California. In Angelakis v. Churchill Management Corp., 1975-76 CCH Fed.Sec.L.Rep. ¶ 95,285 at 98,462-98,463 (N.D.Cal.1975) (Williams, J.), the court held that a complaint alleging fraud in the sale of investment advisory services does not state a claim under either § 10(b) or Rule 10b-5:

"Rule 10b-5 requires that actionable fraud be perpetrated in connection with the purchase or sale of a security. This requirement has been interpreted to mean that a plaintiff usually cannot recover unless he or she is the purchaser or seller of a security which is the subject of a fraudulent transaction. Citations omitted. Plaintiff does not meet this requirement since the alleged fraudulent activities were made in connection with the execution of an agreement authorizing the management of plaintiff's account * * *."

Plaintiffs' contention is contrary to the well-settled requirements governing who may bring private damage actions under the securities laws. Twenty-five years ago the Court of Appeals for the Second Circuit held that plaintiffs may bring damage actions for fraud in connection with the sale of securities only if they actually purchased or sold the securities in question.5Birnbaum v. Newport Steel Corp., 193 F.2d 461, 463-464 (2 Cir.)...

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