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ELLIS v. MERRILL LYNCH & CO.

July 15, 1987

Jerome H. Ellis
v.
Merrill Lynch & Co. and W. A. Schreyer; Jay S. Friedenberg and Marla B. Friedenberg, JT, on behalf of themselves and all others similarly situated v. Merrill Lynch & Co. and W. A. Schreyer



The opinion of the court was delivered by: HANNUM

 HANNUM, S.J.

 The plaintiff, Jerome H. Ellis, in Civil Action No. 86-2865, and the plaintiffs, Jay S. Friedenberg and Marla B. Friedenberg, JT, in Civil Action No. 86-3373, on behalf of themselves and all others similarly situated, bring these actions against the defendants, Merrill Lynch & Co. and its chief executive officer, W. A. Schreyer. In their complaints, the plaintiffs at Count I, allege violations by defendants of Section 10(b) of the Securities and Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 promulgated thereunder. Moreover, the plaintiffs in their complaint further allege at Count II that the defendants violated Section 1962(c) of the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. § 1961, et seq. Counts III, IV and V allege fraud, breach of fiduciary duty and breach of contract under Pennsylvania law.

 The defendants now move to dismiss the plaintiffs' complaints for failure to state a claim upon which relief could be granted. Federal Rule of Civil Procedure 12(b)(6). *fn1" Accordingly, the Court in passing on this motion to dismiss accepts the allegations contained in the plaintiffs' complaints as true. Thus, the questions before the Court are matters of law.

 In this action, the plaintiffs allege that it was the practice of Merrill Lynch & Company and its chief executive officer W. A. Schreyer: (a) to disburse the proceeds from securities sales to the plaintiffs and the plaintiff-class, by using checks drawn on concentration accounts geographically remote either from the location of the branch which maintained the plaintiff-customer's account or from the plaintiff-customer's residence; *fn2" and (b) to delay the crediting of customer dividends or the cash payments thereof until the end of the month or the end of the regular monthly cycle applicable to an individual customer account.

 These practices, the plaintiffs allege, allowed defendants to use unjustifiably their money interest-free for identifiable time intervals.

 I. Securities Fraud Claims

 Defendants assert that these two practices are not "in connection with the purchase and sale" of securities and thus, not in contravention of the anti-fraud provisions of the Exchange Act - that is, § 10(b) of the Exchange Act and Securities and Exchange Commission Rule 10b-5.

 This Court, however, believes that plaintiffs' allegations concerning defendants' method of disbursing proceeds from sales of their customers' securities state a cause of action under the securities laws. In this case, the defendants, by disbursing sale proceeds to their plaintiff-customers by checks drawn on geographically remote banks, in essence misappropriated their clients' funds for identifiable periods of time. Practices of this kind were condemned by the United States Supreme Court in Superintendent of Insurance of the State of New York v. Bankers Life and Casualty Company, 404 U.S. 6, 92 S. Ct. 165, 30 L. Ed. 2d 128 (1971). The Bankers Life decision provides direct support for the position advanced by the plaintiffs.

 More support for this conclusion can be gathered from the Securities and Exchange Commission's view on the specific practice at issue before this Court. Expressing its displeasure with this practice, the SEC commented that:

 Securities and Exchange Act Release No. 15194 (September 28, 1978) (footnotes omitted). *fn3"

 This Court also finds that the defendants' failure to disclose to plaintiffs the source of customer checks constitutes fraud. Broker-dealers, such as defendants, stand as fiduciaries to their clients. It is from this relationship that a duty to disclose the source of customer checks arises. Plaintiffs' allegations not only suffice to show that such a trust relationship existed but also demonstrate that defendants breached the fiduciary duty they owed to the plaintiffs.

 Moreover, this information is material to potential investors especially when one considers that the defendants have, according to the plaintiffs' allegations, an unannounced policy of honoring individual customer requests that sale proceeds be disbursed to them by checks drawn on local banks. This alleged misappropriation and fraud ...


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