Yancoski v. EF Hutton & Co., Inc.

• Decision Date: 23 September 1983
• Docket Number: Civ. A. No. 82-4743.
• Citation: 581 F. Supp. 88
• Parties: Lorraine YANCOSKI v. E.F. HUTTON & COMPANY, INC. and Herbert Krakovitz.
• Court: U.S. District Court — Eastern District of Pennsylvania

581 F. Supp. 88

Lorraine YANCOSKI v. E.F. HUTTON & COMPANY, INC. and Herbert Krakovitz.

Civ. A. No. 82-4743.

United States District Court, E.D. Pennsylvania.

September 23, 1983.

COPYRIGHT MATERIAL OMITTED

David B. Zlotnick, Richard D. Greenfield, Greenfield & Chimicles, Bala Cynwyd, Pa., for plaintiff.

Daniel E. Bacine, Leonard Barrack, Barrack, Rodos & Bacine, Philadelphia, Pa., for defendants.

MEMORANDUM

HANNUM, District Judge.

This is an action brought by Plaintiff Yancoski to recover damages based on allegations of fraud relating to transactions in securities. The Complaint sets forth ten counts. The Court will rule on the Motion Of Defendants To Dismiss The Complaint¹ in which defendants seek dismissal, on various grounds, of all counts.

Summary Of Allegations

The allegations of the Complaint must be accepted as being true.² Accordingly, a distillation of the allegations is presented below.

Lorraine Yancoski received a large sum of money in July of 1979 by means of the satisfaction of a judgment in her favor based on her husband's death. Yancoski sought prudent and safe investments for her funds in order to provide income and capital growth potential.

At her request, plaintiff's attorney introduced her to some stockbrokers, including defendant Krakovitz. Krakovitz worked for the brokerage house of E.F. Hutton & Company, Inc., hereinafter referred to as "E.F. Hutton". Plaintiff was told by Krakovitz that he could invest her money in a manner that was both safe and would lead to income and capital growth. Krakovitz emphasized that the vast research and informational resources of E.F. Hutton would be used to guide her investments.

Based on Krakovitz's statements, plaintiff opened a discretionary account at E.F. Hutton with Krakovitz as the broker in charge of the account. Yancoski placed $100,000.00, the vast majority of her assets, in the account. Before opening her account with E.F. Hutton, plaintiff had not traded in securities and informed Krakovitz of her lack of knowledge of the stock market.

Although plaintiff's objective of safe and prudent investments was known to him, Krakovitz immediately began purchasing stocks for the account which were highly speculative. Krakovitz represented to plaintiff that the stocks purchased for the account were cautious and safe investments. During late 1979 and early 1980, Krakovitz engaged the account in a large amount of trading. In December, 1979 and January, 1980, trading totals were close to the entire value of the account.

In February of 1980, Krakovitz persuaded Yancoski to convert to a margin account by misrepresenting the risks of margin accounts and the suitability of a margin account to plaintiff's investment objectives. Krakovitz is alleged to have induced the conversion to a margin account and subsequently to have used the account solely for the purpose of generating commissions and not to serve Yancoski's interest. The Complaint sets forth a sequence of heavy trading through which the bulk of the account's value was lost while payments for commissions and interest on indebtedness to E.F. Hutton grew.

Plaintiff eventually closed her account with E.F. Hutton and sought relief in this Court based on the heavy trading and misrepresentation by Krakovitz and a failure to supervise the account by E.F. Hutton.

Count I: The Securities Exchange Act Section 10(b) and Rule 10b-5

Plaintiff's first count alleges violations of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b),³ and the Securities and Exchange Commission's Rule 10b-5, 17 C.F.R. § 240.10b-5 (1982).⁴ In effect, Count I of the Complaint sets forth two challenged theories of liability:⁵ (1) Krakovitz violated Rule 10b-5 by engaging the account in excessive trading for the purpose of generating commissions or, in other words, that Krakovitz "churned" the account; and (2) Krakovitz violated Rule 10b-5 by making material misrepresentations concerning and omitting to state material facts regarding the securities transactions.

Defendants properly recognize that Count I complains of "churning"⁶ the account. Defendants contend, however, that churning is not a cognizable violation of either the Act or Rule 10b-5. Instead, maintain Krakovitz and E.F. Hutton, the churning of the account represents a mere breach of a fiduciary relationship and not a manipulative or deceptive act proscribed by federal law.

If churning constitutes only a breach of fiduciary relations, then federal securities law does not cover the activity. See Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 476, 97 S.Ct. 1292, 1302, 51 L.Ed.2d 480 (1977). Churning is, however, more than defendants claim. The cases recognize churning as a deceptive practice which constitutes a violation of Section 10(b) of the Act and Rule 10b-5. E.g., Carras v. Burns, 516 F.2d 251, 258 (4th Cir.1975) (collecting cases); McNeal v. Paine, Webber, Jackson & Curtis, Inc., 598 F.2d 888, 890 n. 1 (5th Cir.1979) (collecting cases). Cf. 17 C.F.R. § 240.15c1-7 (1982) (expressly defining churning as a violation of Section 15(c) of the Act).

Contrary to defendants' contentions, under the circumstances of this case, plaintiff is not required to allege misrepresentations in addition to the excessive trading in order to state a claim under Rule 10b-5.⁷ Therefore, this Court finds that the Complaint does state a claim based on churning.

Defendants also challenge Count I on the ground that it fails to state a claim based solely on misrepresentations by Krakovitz. It is asserted by defendants that plaintiff fails to allege any misrepresentations and, even if misrepresentations are alleged, that there were no misrepresentations made in connection with the purchase or sale of a security. On both grounds, the Court finds defendants' contentions to be without merit.

As the factual background provided earlier indicates, Krakovitz allegedly made several misrepresentations to Yancoski. "Krakovitz represented that he could invest her money in a manner that was completely safe but that would provide income and lead to significant capital appreciation." Complaint at ¶ 11. After purchasing highly speculative stocks for her account, Krakovitz continued to tell Yancoski that only safe and prudent investments were being made. Complaint at ¶ 15. Yancoski was also told that the high volume of trading in her account was normal. Complaint at ¶ 17. When he induced the conversion of the account to a margin account, Krakovitz purportedly misrepresented the risks and appropriateness of the margin-type account. Complaint at ¶ 18. There are other allegations which may be construed as charging misrepresentations, but the Court finds those already stated suffice to demonstrate the propriety of its ruling.

Additionally, the misrepresentations are alleged to be in connection with the purchase or sale of a security. Some misrepresentations were made both before and after the opening of the accounts regarding the prudence of the investments. This Court views those representations as ones "touching" the purchase or sale of securities and, therefore, the "in connection with" requirement is satisfied by the Complaint. See Superintendent of Ins. v. Bankers Life and Cas. Co., 404 U.S. 6, 13, 92 S.Ct. 165, 169, 30 L.Ed.2d 128 (1971); Arrington v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 651 F.2d 615, 619 (9th Cir.1981).

As a result of the foregoing analysis, this Court finds that Count I of the Complaint survives the motion to dismiss.

Count II: Section 12(2) Of The Securities Act

Plaintiff's second count alleges a cause of action under Section 12(2) of the Securities Act of 1933, 15 U.S.C. § 77l(2).⁸ Count II charges misrepresentations by Krakovitz and E.F. Hutton as sellers of securities.

Because matters outside the pleadings were introduced by the parties on this portion of defendants' motion to dismiss pursuant to FED.R.CIV.P. 12(b)(6), the Court will treat the challenge to Count II as a motion for summary judgment.⁹ In this situation, the Court must still accept all of plaintiff's allegations as true and grant judgment only if no genuine issue of material fact is present. Mortensen v. First Federal Sav. & Loan Ass'n, 549 F.2d 884, 891 (3d Cir.1977).

For the purposes of its ruling, the Court will accept defendants' assertion that an action under Section 12(2) will lie only against the purchaser's immediate seller. See Memorandum Of Law In Support Of Defendants' Motion To Dismiss The Complaint, at 10-13.¹⁰

Plaintiff has submitted to the Court several confirmation slips sent to Yancoski by defendants. The confirmation slips carry a designation under "Code C" of "2." See Plaintiff's Memorandum In Opposition To Defendants' Motion To Dismiss, Exhibit A.¹¹ The reverse side of the confirmation slips explain the entry of "2" in this manner: "AS PRINCIPAL WE HAVE BOUGHT FROM YOU OR SOLD TO YOU FOR YOUR ACCOUNT." Additionally, at oral argument on this motion, defendants' counsel conceded that E.F. Hutton was the immediate seller in some of the transactions for the Yancoski account.¹² Consequently, defendants are not entitled to judgment as a matter of law and the motion for summary judgment on Count II is denied.¹³

Count III: "Controlling" Liability Of E.F. Hutton

Plaintiff's third count consists of claims under 15 U.S.C. § 77o¹⁴ and 15 U.S.C. § 78t(a).¹⁵ Both sections provide for joint and several liability of a "controlling person" for violations of the securities laws by a "controlled person."

Defendants assert that Count III fails to state a claim for "controlling person" liability against E.F. Hutton on the basis that no claim for the underlying liability of Krakovitz has been stated. As a result of the Court's disposition of the earlier counts, defendants' position becomes untenable. Accordingly, defendants' motion to dismiss Count III of the Complaint is denied.

Count IV: Civil Liability Under RICO

Plaintiff's fourth count asserts a claim for treble...