United States District Court, Middle District of Pennsylvania
March 20, 1991
JAMES R. DENISON, AND THERESA M. DENISON, PLAINTIFFS,
STEVEN D. KELLY, AND LEGG MASON WOOD WALKER, INC., DEFENDANTS.
The opinion of the court was delivered by: Caldwell, District Judge.
Defendant, Legg Mason Wood Walker, Inc. (Legg Mason), has
filed a motion to dismiss the amended complaint pursuant to
Fed.R.Civ.P. 12(b)(6). The plaintiffs, James R. Denison and
his wife, Theresa M. Denison, filed this lawsuit against Legg
Mason, a stock brokerage, and the other defendant, Steven D.
Kelly, a former broker for Legg Mason, alleging that the
defendants had churned their account and had purchased
investments inappropriate to the plaintiffs' stated desire for
long term growth and appreciation. In considering defendant's
motion, we must accept as true all the well pleaded
allegations of the amended complaint and construe them
favorably to the plaintiffs. The motion cannot be granted
unless the plaintiffs can prove no set of facts in support of
their claims which would entitle them to relief. Labov v.
Lalley, 809 F.2d 220 (3d Cir. 1987).
The amended complaint sets forth the following causes of
action: (1) Count I — a claim pursuant to section 10(b) of the
Securities and Exchange Act of 1934, 15 U.S.C. § 78j(b), and
its corresponding rule, 17 C.F.R. § 240.10(b)-5; (2) Counts II
and III — claims pursuant to section 501 of the Pennsylvania
Securities Act of 1972 (the Securities Act) for purported
violations of sections 401 and 403 of that Act, 70 P.S. §§
1-501, 1-401 and 1-403 (Purdon Supp. 1990-91); (3) Counts IV
through X — pendent state law claims, respectively, for breach
of contract, breach of fiduciary duty, negligence, common law
conversion (Counts VII and VIII), fraud, and civil conspiracy;
(4) Count XI — a claim for a violation of the Pennsylvania
Unfair Trade Practices and Consumer Protection Law (hereinafter
"the CPL"), 73 P.S. § 201-1 (Purdon Supp. 1990-91); and (5)
Count XII — a claim under the Racketeer Influenced And Corrupt
Organizations Act (RICO). 18 U.S.C. § 1961 et seq.
A. The RICO Claim (Count XII).
Plaintiffs' RICO claim is based upon 18 U.S.C. § 1962(a)
which provides, in pertinent part, as follows:
It shall be unlawful for any person who has
received any income derived, directly or
indirectly from a pattern of racketeering
activity . . . in which such person has
participated as a principal within the meaning of
section 2, title 18, United
States Code, to use or invest, directly or
indirectly, any part of such income, or the
proceeds of such income, in acquisition of any
interest in, or the establishment or operation
of, any enterprise which is engaged in, or the
activities of which affect, interstate or foreign
commerce. . . .
Legg Mason attacks the sufficiency of this claim on three
grounds, contending that the plaintiffs have failed to plead
that it has participated as a principal in a pattern of
racketeering activity, citing First National Bank v. Lustig,
727 F. Supp. 276 (E.D.La. 1989) on this issue, that the pattern
of racketeering activity that has been pled is not sufficient,
see Banks v. Wolk, 918 F.2d 418
(3d Cir. 1990), and that the
plaintiffs have failed to plead injury from the investment or
use of income derived from a pattern of racketeering activity
in an enterprise engaged in or affecting interstate commerce.
See Kehr Packages, Inc. v. Fidelcor, Inc., 926 F.2d 1406
Cir. 1991); Rose v. Bartle, 871 F.2d 331
(3d Cir. 1989).
Defendant contends each of these deficiencies is an independent
ground for dismissal of the RICO claim.
Plaintiffs admit that they have not alleged that Legg Mason
participated as a principal in the racketeering activity or
that it aided and abetted Kelly, and that this is a necessary
part of the particular theory under which they have chosen to
pursue Legg Mason on their RICO claim. They assert, however,
that, given the "size" of Legg Mason, "fairness" requires that
they be permitted to engage in some discovery to determine the
extent of Legg Mason's involvement with Kelly's wrongful
handling of their account. (plaintiffs' opposition brief at p.
33). They also cite United States v. Buttram, 432 F. Supp. 1269
(W.D. Pa. 1977) for the proposition that Legg Mason can be
found liable as a principal under 18 U.S.C. § 2 when its agent
Kelly has been "irresponsible." (plaintiffs' opposition brief
at p. 33).
We fail to see the relevance of Buttram to the instant case.
The court in Buttram decided that a criminal defendant could be
found guilty as the principal of an accomplice who was legally
insane at the time of the offenses. The adjudication of guilt
as a principal depended on the conduct of the defendant, not
the mental state of the accomplice. Buttram simply has no
bearing on this case.
As to the asserted need for discovery, we have generally
prohibited a plaintiff from trying to cure deficiencies in a
complaint by engaging in discovery. See Humphrey v. Court of
Common Pleas, 640 F. Supp. 1239 (M.D.Pa. 1986). This approach is
consistent with Fed.R.Civ.P. 11 which contemplates that a
party's attorney will sign the complaint only "after reasonable
inquiry" establishes that the complaint "is well grounded in
fact and is warranted by existing law. . . ." (emphasis added).
See also Kaylor v. Fields, 661 F.2d 1177, 1184 (8th Cir. 1981)
("Discovery should follow the filing of a well-pleaded
complaint. It is not a device to enable a plaintiff to make a
case when his complaint has failed to state a claim."); Avnet,
Inc. v. American Motorists Insurance Co., 115 F.R.D. 588
There may be circumstances in which we would permit
discovery to proceed even though a complaint has failed to
state an essential element of a plaintiff's chosen theory of
recovery. But we do not think that the mere size of the
defendant or a general plea for fairness justifies doing so.
Accordingly, we conclude that the complaint fails to state a
RICO claim because it does not allege that Legg Mason was a
principal in a pattern of racketeering activity or aided and
abetted that activity.
In any event, we agree with Legg Mason's third ground for
dismissal of the RICO claim. Plaintiffs have failed to allege
that they have been injured by the use or investment of income
derived from a pattern of racketeering activity, or the
proceeds thereof, in an enterprise in, or affecting,
interstate commerce. This is a required element of a cause of
action under section 1962(a). See Kehr Packages, supra; Rose,
supra; Zimmer v. Gruntal & Co., 732 F. Supp. 1330 (W.D.Pa.
Plaintiffs' brief attempts to satisfy this burden by
pointing to that portion of
paragraph 85(B)(3) of the plaintiffs' amended complaint which
predicates Legg Mason's RICO liability on the mere use or
investment of the income derived from the plaintiffs by its
racketeering activity in its business. This allegation is
still insufficient for a section 1962(a) claim. See Leonard v.
Shearson Lehman/American Express Inc., 687 F. Supp. 177 (E.D.Pa.
1988) (investment of racketeering income in a business
affecting interstate commerce is insufficient for a RICO
claim). See also Bhatla v. Resort Development Corp.,
720 F. Supp. 501, 508 (W.D.Pa. 1989) (liability under § 1962(a)
cannot be predicated upon the "mere receipt of money derived
from a pattern of racketeering activity" nor solely on its
"investment in an enterprise affecting interstate commerce").
We recognize that Roche v. E.F. Hutton & Co., Inc., 658 F. Supp. 315
(M.D.Pa. 1986) is to the contrary but that case was decided
prior to the Third Circuit's decision in Rose, supra.
For the foregoing reasons, the plaintiffs' RICO claim
against Legg Mason will be dismissed.*fn1
B. The Consumer Protection Act Claim (Count XI).
Legg Mason next contends that the plaintiffs cannot make a
claim under the CPL for alleged wrongdoing arising from
securities transactions. Legg Mason makes this claim despite
the very broad language of the CPL which seemingly covers the
conduct at issue.
The CPL declares unlawful "[u]nfair methods of competition
and unfair or deceptive acts or practices in the conduct of
any trade or commerce as defined in [section 201-2(4)(i)
through xvii]. . . ." (brackets added). 73 P.S. § 201-3. Trade
and commerce are defined, in part, as "the sale or distribution
of any services. . . ." Id. at § 201-2(3). Section 201-2, after
enumerating several specific unfair trade practices, contains a
catch-all provision, which the plaintiffs rely on, defining an
unfair method of competition as "any other fraudulent conduct
which creates a likelihood of confusion or of
misunderstanding." 73 P.S. § 201-2(4)(xii). Further, section
201-9.2, in pertinent part, authorizes individuals to sue for
violations of section 201-3, when they purchase "services
primarily for personal, family or household purposes. . . ."
Finally, the CPL contains a specific exemption only for radio,
television and newspapers acting in good faith. 73 P.S. §
201-3. It does not similarly exempt from its coverage the
business of securities.
Thus, plaintiffs appear to meet all the requirements of the
CPL. They allege that they purchased the defendant's brokerage
services for their personal portfolio and that they suffered
injury because the defendant engaged in fraudulent conduct in
connection with the handling of their account.
Despite the broad scope and remedial nature of the CPL,
defendant contends it provides the plaintiffs no relief,
citing in its support cases from other jurisdictions which
have held for a variety of reasons that consumer protection
laws with language comparable to Pennsylvania's do not extend
to securities transactions. See Spinner Corp. v. Princeville
Development Corp., 849 F.2d 388 (9th Cir. 1988) (Hawaii law);
Stephenson v. Paine, Webber, Jackson & Curtis, Inc.,
839 F.2d 1095 (5th Cir. 1988) (Louisiana law); Lindner v. Durham Hosiery
Mills, Inc., 761 F.2d 162 (4th Cir. 1985) (North Carolina law);
Skinner v. E.F. Hutton Co., Inc., 314 N.C. 267, 333 S.E.2d 236
(1985) (North Carolina law); Swenson v. Englestad,
626 F.2d 421 (5th Cir. 1980) (Texas law); Nichols v. Merrill Lynch
Pierce Fenner & Smith, 706 F. Supp. 1309 (M.D.Tenn. 1989); In re
Catanella, 583 F. Supp. 1388 (E.D.Pa. 1984) (New
Jersey law); Taylor v. Bear Sterns, 572 F. Supp. 667 (N.D.Ga.
1983) (Georgia law); Russell v. Dean Witter Reynolds, Inc.,
200 Conn. 172, 510 A.2d 972 (1986) (Connecticut law); Cabot Corp.
v. Baddour, 394 Mass. 720, 477 N.E.2d 399 (1985) (Massachusetts
law); State ex rel. McLeod v. Rhoades, 275 S.C. 104,
267 S.E.2d 539 (1980) (South Carolina law); State v. Piedmont Funding
Corp., 119 R.I. 695, 382 A.2d 819 (1978) (Rhode Island law).
We have carefully reviewed these cases and we must agree
with the plaintiffs that they cannot control the outcome here.
Initially, we note that Rhoades and Piedmont Funding are easily
distinguishable because the consumer protection laws at issue
in those cases contained specific exemptions for conduct
regulated or permitted by governmental agencies or statute. The
CPL contains no similar exemption.
The remaining cases share what appear to be the typical
reasons for refusing to allow a securities claim under state
consumer protection laws. Thus, it is noted that some of these
laws were patterned after the Federal Trade Commission Act
(FTC Act), 15 U.S.C. § 45(a)(1), and the latter statute has
never been construed as applying to securities transactions.
See Stephenson, Lindner, Skinner and Russell. Moreover,
previous state court reliance on the FTC Act for guidance in
construing these laws has also been viewed as an indication
that consumer protection laws should not be read to encompass
securities transactions. See Stephenson. The comprehensive
nature of state securities laws, which often provide private
remedies substantively different from the applicable consumer
protection laws, lead some courts to conclude they should not
interfere with legislative statutory schemes supposedly
providing coordinated coverage in different areas. See Spinner,
Lindner, Nichols, Cabot, In re Catanella, Skinner and Russell.
Other reasons include: (1) the availability of treble
damages under consumer protection laws, but not under state
securities laws, which makes it unlikely that state
legislatures intended the more liberal consumer remedy to be
available for securities violations, see Spinner, Stephenson,
Lindner and Skinner; (2) the potential for an undesirable
overlapping of authority between state officials in charge of
consumer protection and those in charge of securities
regulation, see Stephenson, Lindner and Skinner; (3) simply the
federal predominance in the area of securities transactions,
see Nichols; and that (4) securities transactions are just
qualitatively different from the usual run of consumer
transactions intended to be covered by consumer protection
laws. See In re Catanella.
These reasons all have some validity and the issue is
certainly arguable. But our review of Pennsylvania law leads
us to believe that the Pennsylvania Supreme Court would
approach the issue differently.
To begin with, we believe the supreme court would look first
to the language of the statute rather than engage in a
somewhat loose analysis, independent of the statutory
language, of what the Pennsylvania General Assembly intended
to be covered by the CPL. Of course, the "object of all
interpretation and construction of statutes is to ascertain
and effectuate the intention of the General Assembly," 1 Pa.
C.S. § 1921(a), but "[w]hen the words of a statute are clear
and free from all ambiguity," id. at § 1921(b) (brackets
added), that intent should be found in the statutory language
itself. See Coretsky v. Board of Commissioners, 520 Pa. 513,
555 A.2d 72 (1989); In re Estate of Fox, 494 Pa. 584,
431 A.2d 1008 (1981); Garcia v. Community Legal Services Corp.,
362 Pa. Super. 484, 524 A.2d 980 (1987). As noted above, and as the
moving defendant concedes, the relevant sections of the CPL
plainly and unambiguously cover the alleged conduct of the
defendants in connection with the security transactions at
issue in the instant case.
The cases cited by defendant also seem to be greatly
concerned about the need to coordinate comprehensive, but
potentially overlapping, statutory schemes. They do not wish
to disturb the schemes by permitting an overlap. Conversely,
we do not believe that Pennsylvania courts would view
coordination as an overriding concern.
Rather, the issue would simply be whether the General Assembly
"intended the [Securities Act] and the CPL to coexist as
independent statutory mechanisms or whether the [Securities
Act] is intended to provide the sole and exclusive statutory
penalty for alleged" securities violations. Pekular v. Eich,
355 Pa. Super. 276, 289, 513 A.2d 427, 433 (1986) (brackets
added). If the General Assembly intended the former, then,
despite the comprehensiveness of the Securities Act, a claim
could be brought under the CPL as well as that Act.
Pekular is instructive although it dealt with whether a
violation of the Unfair Insurance Practices Act (UIPA), 40 P.S.
§ 1171.1 et seq. (Purdon Pamphlet 1990-91), could also be
redressed under the CPL. The superior court held that it could,
despite the broad and sweeping language of the UIPA. In its
support, the court noted the remedial nature of the CPL, prior
Pennsylvania cases in which violations of other statutes had
been held to be redressable under the CPL, and that section
201-3 provided certain exemptions from the CPL but did not
include insurance companies or their agents within the
exemption. Comparing the two statutes, the court also found no
irreconcilable conflict prohibiting enforcement of them both:
The UIPA vests the Insurance Commissioner with
the power to investigate specifically defined
acts and practices of insurers, to levy limited
monetary penalties, and to suspend or revoke
licenses. The CPL on the other hand affords an
aggrieved consumer a private statutory remedy by
which he may receive compensation for statutorily
defined wrongs done to him in the course of any
trade or business. We see no inconsistency
between the UIPA providing for administrative
investigation and an imposition of limited
penalties and the CPL providing a means by which
a consumer may privately seek compensation for
wrongs allegedly suffered. Our conclusion that
there is no inherent irreconcilable conflict is
supported by the fact that the UIPA contains no
provision either stating or implying that the
power vested in the Insurance Commissioner
represents the exclusive means by which an
insurer's unfair or deceptive acts are to be
penalized or that the insured is precluded from
seeking private compensation for damages
Id. at 289-90, 513 A.2d at 434.
We think the same rationale applies here although, unlike
the UIPA, the Securities Act does provide a private cause of
action. The key, however, is that there is no irreconcilable
conflict. Both laws can operate at the same time. We must
therefore enforce them both. Id. We thus reject the defendant's
contention, which relies upon 1 Pa. C.S. § 1933, that the
specific statute must override the general simply because they
both can be applied to securities transactions. Section 1933
imposes the further requirement that there be an
"irreconcilable" conflict before the more specific statute
It is also significant that, like the UIPA, the Securities
Act nowhere indicates that it is intended as the exclusive
statutory remedy for securities violations. In fact, as
pointed out by the plaintiffs, it specifically preserves other
remedies. Section 1-506 provides, in pertinent part, that:
"Nothing in this act shall limit any liability which might
exist by virtue of any other statute or under common law if
this act were not in effect." 70 P.S. § 1-506. "Any other
statute" must encompass the CPL. We recognize that Cabot,
supra, construed a somewhat similar provision as preserving
only common law causes of action but the provision at issue in
that case preserved "rights and remedies . . . that may exist
at law or in equity. . . ." 394 Mass. at 726, 477 N.E.2d at
402. This language could be construed as preserving only common
law remedies. In contrast, the Pennsylvania saving provision
makes an explicit reference to statutory remedies.
We have no concern about the other reasons which have been
advanced against permitting a cause of action under the CPL
for a securities claim.
Those courts which have cited the availability of treble
damages under consumer protection laws have had to deal with
which make such damages mandatory, see Spinner, supra; Lindner,
supra, or at least mandatory upon the satisfaction of certain
conditions. See Stephenson, supra. In contrast, the CPL allows
treble damages solely in the discretion of the court. See 73
P.S. § 201-9.2. See also Smith v. Chrysler Motors Corp.,
1990 WL 65700 (E.D.Pa.) (award of treble damages is within the
discretion of the court and is appropriate under the CPL only
when conduct would justify award of punitive damages).
The argument that permitting such a cause of action would
create overlapping areas of authority between the Pennsylvania
Securities Commission and the Bureau of Consumer Protection is
speculative. We cannot, in any event, evade the plain meaning
of the CPL to guard against this potential problem.
It is also true that the Pennsylvania Supreme Court looks to
the FTC Act for guidance in interpreting the CPL. See
Commonwealth v. Monumental Properties, Inc., 459 Pa. 450,
329 A.2d 812 (1974). But it is for guidance only. While we cannot
predict these matters with certainty, we do not think that the
state supreme court would prohibit a claim under the CPL for
securities violations, given the remedial nature of that
statute, the broad language making it applicable here, the
exemption provision failing to exempt brokerages or stock
brokers, and the saving provision in the Securities Act
explicitly preserving "any other statutory" remedy.
Our conclusion is consistent with the one case we have been
able to locate dealing with this issue under Pennsylvania law.
In McCullough v. Shearson Lehman Brothers, Inc., 1988 WL 23008
(W.D.Pa.), the court denied a motion to dismiss a CPL claim
based upon fraudulent securities transactions. The court
reasoned as follows:
We will deny defendants' motion to dismiss
Count IV; we reject their contention that the
Unfair Trade Law cannot support a claim for
securities fraud. . . . Although the investment
field is not mentioned in this Law, we must
interpret this act liberally to cover "generally
all unfair and deceptive acts or practices in the
conduct of trade or commerce." Culbreth v. Lawrence
J. Miller, Inc. [328 Pa. Super. 374], 477 A.2d 491,
501 (Pa.Super. 1984), quoting Commonwealth v.
Monumental Properties, Inc. [459 Pa. 450],
329 A.2d 812, 826 (Pa. 1974).
The legislature did not exclude stockbrokers
from the coverage of the Law, as it could have in
§ 201-3 where publishers are excluded. "Exceptions
expressed in a statute shall be construed to
exclude all others." 1 Pa. C.S.A. § 1924 (Purdon's
Supp. 1987); Culbreth, supra, [477 A.2d] at 496. No
claim can be made that the state securities laws
override the Unfair Trade Law or common law
remedies. 70 P.S. § 1-506 (Purdon's Supp. 1987);
Ging v. Parker-Hunter, Inc., 544 F. Supp. 49, 52
(W.D.Pa. 1982). We find that the lack of any
brokerage exclusion, the liberal construction and
the extensive language in the Unfair Trade Law
require a denial of the motion to dismiss Count IV.
It is also consistent with State ex rel. Corbin v. Pickrell,
136 Ariz. 589, 667 P.2d 1304 (1983) (claim based upon
securities transactions could be brought under Arizona Consumer
Fraud Act after that Act was amended to provide, in part, that
it was "in addition to all other causes of action" available in
C. The Civil Conspiracy Claim (Count X).
Legg Mason asserts that the civil conspiracy claim must be
dismissed because it is based upon a conspiracy between Legg
Mason and Kelly. Defendant cites cases which have held that a
corporation is incapable of conspiring with one of its
employees, relying principally upon Jagielski v. Package
Machinery Co., 489 F. Supp. 232 (E.D.Pa. 1980) and Yancoski v.
E.F. Hutton & Co., Inc., 581 F. Supp. 88 (E.D.Pa. 1983).
Plaintiffs counter that two or more employees may be found
capable of conspiring with each other under federal civil
rights laws, see Gant v. Aliquippa Borough,
612 F. Supp. 1139 (W.D.Pa. 1985), and that several physicians have
been found capable of conspiring together although they were
part of a "single entity" — the same hospital staff. See
Gordon v. Lancaster Osteopathic Hospital Ass'n, Inc.,
340 Pa. Super. 253, 489 A.2d 1364 (1985). Plaintiffs therefore argue
that it would be inappropriate to dismiss their civil
conspiracy claim at this point because they may find through
discovery other employees of Legg Mason who conspired with
Kelly. This discovery may also reveal a conspiracy between
Kelly and Legg Mason, with the latter operating through
"another authorized agent of Legg Mason." (plaintiffs' brief at
It may be possible for two or more employees of a
corporation to conspire. See St. John Mortgage Co., Inc. v.
United States Fidelity And Guaranty Co., 1988 WL 138700
(E.D.Pa.) (corporate employees may be capable of a civil
conspiracy under Pennsylvania law when acting beyond the scope
of their employment or for their own personal interests),
revers'd on other grounds, 897 F.2d 1266 (3d Cir. 1990). But
the plaintiffs have not sued Legg Mason employees alone. They
have sued Legg Mason itself, charging it with having conspired
with Kelly "and/or other Legg-Mason agents or employees."
(amended complaint, ¶ 77). Thus, plaintiffs' argument that
there may have been a conspiracy between Legg Mason employees
has no relevance to Legg Mason's motion.
A corporation cannot conspire with one or more of its
employees when those employees are acting in their authorized
capacities on behalf of the corporation. See Polay v. West
Company, 1990 WL 59351 (E.D.Pa.) (dictum). Plaintiffs have not
alleged that Kelly has acted in any capacity other than that of
his position as a stock broker for Legg Mason. Compare Sanzone
v. Phoenix Technologies, Inc., 1990 WL 50732 (E.D.Pa.)
(corporation can conspire with corporate officers when the
officers could also have been perceived as acting in their
capacities as shareholders). Therefore, any conspiracy claim
against Legg Mason which depends upon Kelly's involvement must
Additionally, we have already concluded that discovery would
be inappropriate to determine if a cause of action exists.
Thus, the civil conspiracy claim cannot be upheld on the basis
that plaintiffs may discover that other Legg Mason employees
were involved in the alleged scheme. Further, in regard to
Legg Mason's potential liability, there is no indication that
discovery would reveal in what capacity these other, unknown
agents of Legg Mason were operating. The civil conspiracy
claim against Legg Mason will be dismissed.
D. The Adequacy of the 10-b Claim, the Pennsylvania
Securities Act Claims, And the Common Law Fraud Claim
(Counts I, II, III and IX).
Legg Mason next attacks the adequacy of count I, the 10b-5
claim, counts II and III, the Pennsylvania Securities Act
claims, and Count IX, the common law fraud claim. It asserts
that these claims are deficient to the extent that they are
based solely upon unauthorized trading. Citing among other
cases, Shamsi v. Dean Witter Reynolds, Inc., 743 F. Supp. 87
(D.Mass. 1989) and Bischoff v. G.K. Scott & Co., Inc.,
687 F. Supp. 746 (E.D.N.Y. 1986), defendant argues that unauthorized
trading fails to satisfy the "in connection with" requirement
of the 10b-5 claim,*fn2 and that reliance is lacking for the
fraud claim, when plaintiffs, by the very nature of
trades, could have had no knowledge of alleged omissions or
misrepresentations.*fn3 Reliance is an essential part of a
common law fraud claim. See Mellon Bank Corp. v. First Union
Real Estate Equity And Mortgage Investments, 750 F. Supp. 711
We reject this argument because, as the plaintiffs have
correctly pointed out, the defendant has failed to take into
account all of the allegations of the amended complaint.
Reading the complaint as a whole, the plaintiffs have
alleged that, in the last half of April 1987, they authorized
Kelly to open a securities account on their behalf with Legg
Mason. (amended complaint, ¶ 8). They informed both defendants
at that time, and during the subsequent operation of the
account, that their "primary objective" was "long term-growth
and appreciation." (¶ 9). Kelly reassured the plaintiffs while
he managed their account that the activity in their account was
normal and consistent with their objective. (¶ 25).
However, instead of following the plaintiffs' stated
objective, the account was operated as both a margin and
options account. (¶ 10). Plaintiffs had never authorized the
account to be operated in this fashion, (¶ 17), and no one from
Legg Mason ever informed them of the terms and conditions of
such Legg Mason accounts, their characteristics, or the risks
involved. (¶¶ 18, and 19). The plaintiffs' signatures on
documents purportedly authorizing margin and options trading
were forged. (¶ 22).
Kelly used his fiduciary relationship with the plaintiffs,
and certain "false information" on the documents authorizing
the margin and options trading, to assert control over the
account from its inception until May 11, 1990, when Legg Mason
removed him as manager of its Harrisburg office and forced him
to resign as a sales agent. (¶¶ 23, 10 and 6). This control
enabled Kelly to engage in a series of unauthorized securities
transactions and to churn the account, all to the detriment of
It is the unauthorized nature of these transactions, coupled
with the alleged failure to advise the plaintiffs of the
characteristics and risks of these transactions, which
defendant has seized upon in arguing that, at least to the
extent that the claims are based upon unauthorized trades,
they are not actionable. It is apparent, however, that the
securities claims are not just based upon unauthorized trades.
The crucial allegations are that the plaintiffs informed the
defendants at the beginning of their relationship that they
wanted long term growth and appreciation and that, despite the
defendants' awareness of this goal, both risky and unsuitable
securities were purchased for the plaintiffs' account.
Moreover, Kelly falsely informed the plaintiffs that the
account was being handled in a manner consistent with their
Both the failure to inform the plaintiffs of the true nature
of the transactions and the actual misrepresentation would be
the type of fraudulent conduct proscribed by Rule 10b-5 and
would also satisfy common law fraud. Nor would this conduct
have to be connected, at least in the instant case and in the
posture in which the argument has been raised, to a purchase
or sale of a particular security. See Angelastro v.
Prudential-Bache Securities, Inc., 764 F.2d 939 (3d Cir. 1985);
In re Catanella, 583 F. Supp. 1388 (E.D.Pa. 1984).*fn4 We would
also note our belief that churning is actionable under Rule
10b-5. See In re Catanella.
E. The Specificity of the 10-b Claim, the Pennsylvania
Securities Act Claims, And the Common Law Fraud Claim
Counts I, II, III and IX.
Relying upon Fed.R.Civ.P. 9(b), requiring specificity in the
pleading of fraud, Legg Mason has also attacked the
specificity of counts I, II, III and IX as they relate to the
averments of churning, a constructive fraud, see Roche, infra,
and the purchase of "unsuitable" investments.
Defendant contends that the churning allegations in
paragraph 24 are too vague because they merely recite in
conclusional fashion the case law definition of churning
without setting forth facts "which would permit a
determination of either the turnover ratio of the account,
or the percentage of the account value paid in commissions."
Roche v. E.F. Hutton & Co., Inc., 603 F. Supp. 1411, 1416
(M.D.Pa. 1984) (emphasis in original) (quoted case omitted). In
pertinent part, paragraph 24 alleges that Kelly "initiat[ed]
transactions in the account that were excessive in view of the
Plaintiffs' investment goals and the character of the account .
. . [which] included frequent in-and-out trading of securities.
. . ." (brackets added).
Citing Gopez v. Shin, 736 F. Supp. 51 (D.Del. 1990),
plaintiffs counter that, by identifying the account, and by
pleading the time period during which it was churned along with
the elements of a churning claim, they have met their pleading
requirement. Given the particular allegations of the amended
complaint, we agree with the plaintiffs.
Those allegations identify the particular account which was
the subject of the churning claim, the time frame within which
the alleged churning occurred, April of 1987, until May 11,
1990, (amended complaint, ¶ 24), and those transactions which
were authorized and approved by the plaintiffs, thereby
identifying as well the unauthorized trades. (¶ 14).
Additionally, the plaintiffs have identified as part of their
churning claim the options and warrants transactions in their
account, (¶ 24), and have identified specific stocks as
examples of stock which was unsuitable for their account, given
their investment goal. (¶ 16). These allegations are sufficient
for the defendant to determine the approximate turnover ratio
or the amount of excessive commissions. Compare Roche, supra,
603 F. Supp. at 1419-20 (allegations which merely cite certain
trades deemed inappropriate by the plaintiff are insufficient
for a churning claim).
We realize that plaintiffs in other cases have provided more
detail by way of attaching monthly account statements to their
complaint, citing examples from the statements of churning,
and estimating the turnover ratio for the chosen months or
illustrative time period. See Roche, supra, 603 F. Supp. 1417 n.
5; Gopez, supra; Prodex, Inc. v. Legg Mason Wood Walker, Inc.,
1987 WL 6329 (E.D.Pa.). But as noted by the court in Gopez,
these more specific allegations would not necessarily be more
helpful in determining the validity of the churning claim. We
would also note that the plaintiffs need not allege the
turnover ratio or the percentage of account value paid in
commissions. Rather, they need only provide sufficient facts so
that the defendant can make these calculations. Gopez. We
believe the plaintiffs have done that here.
Legg Mason has also contested the specificity of the
plaintiffs' separate claim that "unsuitable" stock was chosen
for their account. To the extent that the purchase of
unsuitable stock was part of a fraudulent scheme or practice,
specificity would be required.
As noted, paragraph 16 of the amended complaint lists
specific examples of stock the plaintiffs considered
unsuitable because they were "highly speculative" and also
alleged that the "other unauthorized purchases of securities
traded over-the-counter" were unsuitable as well. As also
noted, the plaintiffs elsewhere in the complaint additionally
alleged that they wanted long term growth and appreciation. We
believe that these allegations are specific enough for an
unsuitability claim. See Gopez, supra.
F. The Statutes of Limitations For The 10b-5 Claim and The
Pennsylvania Securities Act Claims (Counts I, II and
1. The 10b-5 Claim.
In In re Data Access Systems Securities Litigation,
843 F.2d 1537, 1550 (3d Cir. 1988) (en banc), the Third Circuit held
that 10b-5 claims would be subject to a statute of limitations
barring actions brought more than "one year after the plaintiff
discovers the facts constituting the violation, and in no event
more than three years after such violation." The original
complaint in the instant case was filed on September 28, 1990.
Legg Mason therefore argues that the 10b-5 claim is barred to
the extent it is based on transactions in the account occurring
prior to September 28, 1987. Additionally, because the
plaintiffs failed to allege fraudulent concealment with
sufficient specificity, the claim is barred to the extent it is
based on transactions occurring prior to September 28, 1989.
In opposition, plaintiffs assert that, despite their attempt
to plead facts which would defeat a statute of limitations
defense, they had no obligation to do so. Thus, defendant
cannot rely on these allegations to attack plaintiffs' 10b-5
claim. In any event, the allegations are sufficiently specific
and resolution of the limitations issue must await another
stage of the litigation.
We need not resolve the issue of whether plaintiffs had the
duty of pleading facts which would show that their claim was
timely. Once the plaintiffs decided to address the limitations
issue in their complaint, the defendant was entitled to
challenge by motion the adequacy of the averments of
fraudulent concealment. See Alfaro v. E.F. Hutton & Co., Inc.,
606 F. Supp. 1100, 1107 (E.D.Pa. 1985); Fitch v. Radnor
Industries, Ltd., 1990 WL 150110 (E.D.Pa.).
However, contrary to the defendant's position, the
plaintiffs need not further allege facts which would support
their due diligence in attempting to discover the fraud. Legg
Mason quotes the following language from Alfaro, supra, to
support that contention: "[T]he complaint must set forth the
time and circumstances of the discovery of the fraudulent
statements . . . and the diligent efforts which plaintiff
undertook in making or seeking such discovery." 606 F. Supp. at
1112. (brackets added) (quoted case omitted). But at that point
in the opinion, the court was discussing the necessary
allegations for a claim under section 12(2) of the Securities
Act of 1933, which, because it established its own limitations
period for section 12(2) actions, see 15 U.S.C. § 77m, required
allegations of due diligence in the complaint.
In the instant case, we are dealing with a 10b-5 claim,
governed by a judicially created limitations period borrowed
from the Securities and Exchange Act of 1934. See In re Data
Access, supra, 843 F.2d at 1550. Therefore, we need only
concern ourselves with whether the plaintiffs, having raised
fraudulent concealment in their complaint, have pled an
adequate factual support for that position. See Alfaro, supra,
606 F. Supp. at 1107.
Plaintiffs' allegations of fraudulent concealment are set
forth in paragraph 25 of their amended complaint:
Plaintiffs did not discover the improprieties
or violations alleged herein until after Sept.
18, 1989. Moreover, from the opening of the
account in April of 1987 and throughout the time
period up to and including May 11, 1990, Kelly
utilized the trust and confidence of Plaintiffs,
his expertise and an ongoing series of
representations, omissions, obfuscations and
other actions to withhold from Plaintiffs, and
confuse or delay Plaintiffs' discovery of, the
true status of their account and the nature of
the transactions Kelly initiated in their account
by, inter alia,: asserting that account statements
did not accurately reflect trades in the
Plaintiffs' account; urging Plaintiffs not to be
concerned with particular transactions but to rely
on Kelly's strategies to make them money overall;
assuring Plaintiffs that Kelly would "look into"
items questioned by the Plaintiffs and get back to
them if anything improper had occurred; and
reassuring Plaintiffs that the activities in
their account were normal and consistent with
These allegations are not sufficiently specific. The
plaintiffs speak in conclusional language of "an ongoing
series of representations, omissions, obfuscations and other
conduct" which prevented them from finding out what was really
happening in their account. The plaintiffs do list some
specific examples, but by using the term "inter alia," they
signal they are also relying upon other conduct they have not
specified in the complaint. In any event, the examples given
are not specific enough because the plaintiffs have also not
set forth how often these events happened, when they happened,
and the circumstances under which these communications were
made to the plaintiffs, including who initiated the contact
leading to the communications and whether they were written or
oral. See Alfaro, supra.
The substance of the communications may also not be exact
enough. Plaintiffs should allege, for example, what trades, if
any, may have been at issue when Kelly said that the account
statements were not accurate, what particular transactions, if
any, were of concern when he advised them to rely upon his
overall strategy, and the items he was going to look into for
Without more specificity, we cannot say if conduct more than
one year before the beginning of this lawsuit is actionable.
But we will not rule against the plaintiffs at this time, as
the defendant urges us to do. Rather, plaintiffs will be given
leave to file an amended complaint to see if they can cure the
deficiencies in their allegations of fraudulent concealment.
As to conduct more than three years before the lawsuit
started, we agree with the defendant that a 10b-5 claim based
on such conduct is now time barred. The three year limitations
period adopted by the Third Circuit in In re Data Access,
supra, is a statute of repose and is not subject to equitable
tolling. Id. Thus, the discovery rule or fraudulent concealment
is not relevant to this portion of the claim and we will
dismiss it to the extent it is based on the defendants' conduct
occurring more than three years before the lawsuit started.
2. The Pennsylvania Securities Act Claims.
For the state securities causes of action set forth in
Counts II and III of the amended complaint, the Securities Act
provides a limitations period of "four years after the act or
transaction constituting the violation" or "one year after the
plaintiff receives actual notice or upon the exercise of
reasonable diligence should have known of the facts
constituting the violation, whichever shall first expire." 70
P.S. § 1-504(a) (Purdon Supp. 1990-91).
Based upon the same argument made above concerning the
inadequacy of plaintiffs' averments of fraudulent concealment,
Legg Mason argues that the state law securities claims must be
dismissed to the extent that they are based upon conduct
occurring more than one year before the lawsuit was initiated.
We must in turn, based upon our analysis above, reject this
G. The Statute of Limitations And the Pendent State Common
Law Claims (Counts V, VI, VII and IX).
Legg Mason contends that Counts V, VI, VII, and IX, setting
forth claims for breach of fiduciary duty, negligence,
conversion, and common law fraud must be dismissed to the
extent that they are based upon conduct occurring more than
two years prior to the filing of the original complaint.
See 42 Pa. C.S. § 5524(7).
The discovery rule would apply to these causes of action.
See generally Garcia v. Community Legal Services Corp., 362 Pa. Super. 484,
524 A.2d 980 (1987). Accordingly, based upon our
foregoing discussion of the plaintiffs' allegations of
fraudulent concealment we will deny defendant's motion.
We will issue an appropriate order.
AND NOW, this 20th day of March, 1991, upon consideration of
the motion to dismiss filed by defendant, Legg Mason, it is
1. Counts X and XII of the complaint, the civil
conspiracy claim and RICO claim, respectively,
are dismissed without leave to amend, as against
the defendant Legg Mason only.
2. The motion to dismiss Counts I, II and III
for failure to plead fraudulent concealment with
sufficient specificity is granted for conduct
occurring prior to September 28, 1989, and for
Counts V, VI, VII and IX for conduct occurring
prior to September 28, 1988, except that
plaintiffs are hereby given leave to file a
second amended complaint by April 10, 1991, which
cures the deficiencies in the amended complaint
noted in the accompanying memorandum.
3. The motion to dismiss Count I, the 10b-5
claim, is granted as to Legg Mason to the extent
the claim is based upon conduct that occurred
prior to September 28, 1987.
4. In all other respects, Legg Mason's motion
to dismiss is denied.