| Fund Democracy |
Donald PRESS, as Trustee of Donald PRESS, P.C. EMPLOYEES PROFIT SHARING PLAN & TRUST U/A DTD 6/27/80 individually, and on behalf of all others similarly situated Patterson Irrevocable Trust, Plaintiff,
v.
QUICK & REILLY, U.S. CLEARING CORP., and QUICK & REILLY GROUP, INC. Defendants. No. 96 CIV. 4278(RPP).
Aug. 8, 1997.
Andrea Bierstein, Richard L. Store, Kaufman, Malchman, Kirby & Squire, LLP, New York, New York, For Plaintiff.
A. Robert Pictrzak, Brown & Wood, L.L.P., New York, New York, For Defendants.
OPINION AND ORDER
ROBERT P. PATTERSON JR. District Judge.
Defendants Quick & Reilly, Inc., U.S. Clearing Corp., and their parent Quick & Reilly Group, Inc. (collectively "Defendants") move to dismiss the Amended Class Action Complaint ("Complaint") pursuant to Fed.R.Civ.P. 12(b)(6), 9(b), and 12(b)(1). Background Plaintiff Donald Press, as Trustee of Donald Press, P.C. Employees Profit Sharing Plan and Trust U/A DTD 6/27/80 ("Press") has brought this putative class action on behalf of all persons or entities who, [from 1980 to Present], have maintained a brokerage account with defendants or for whom U.S. Clearing served as clearing broker, and whose monies in such account(s) were swept into a money market fund, that, either directly or through the fund's advisor, administrator, or another affiliate, paid Fees to defendant(s), with respect to which defendants (a) failed to make disclosure in accordance with rule 10b-10 and rule 10b-5 and/or (b) failed to obtain the consent of its customers consistent with the requirements of New York law. (Compl.§ 34.)
The Complaint alleges that Press maintained a brokerage account with Quick & Reilly, Inc. ("QRI"), which clears trades through an affiliate, U.S. Clearing Corp. ("U.S.Clearing") [FN1]; and that from June 1994 to April 1995, Defendants swept amounts from Press' account into the Alliance Capital money market funds ("Alliance") including Alliance Money Reserves Money Market Fund ("AMR Fund") and the Alliance Prime Portfolio Money Market Fund ("APP Fund") and received fees from Alliance. (Compl.§ 23.) The Complaint also alleges that U.S. Clearing shares its fees with the introducing brokers, including QRI; that under a clearing agreement U.S. Clearing pays its introducing brokers amounts up to 35 basis points out of the fees it receives from Alliance; that Alliance therefore pays U.S. Clearing at least 35 basis points; and that defendants' monthly statements or confirmations to plaintiff do not disclose their receipt of such fees or their amount. (Compl.§ 20, 28.)
FN1. The Complaint alleges that Quick & Reilly Group is liable for the actions of QRI and U.S. Clearing as a control person under § 20 of the Securities Exchange Act. (Compl.§ 15.) End of footnote.
The Complaint brings four causes of action against the defendants: 1) violation of Section 10(b) of the Securities Exchange Act of 1934 and Rules 10b-5 and 10b-10 thereunder; 2) breach of fiduciary duty; 3) common law fraud; and 4) unjust enrichment.
DISCUSSION
In a motion to dismiss, a district court must view the complaint in the light most favorable to the plaintiff, accepting allegations contained in the complaint as true. See Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 40 L.Ed.2d 90 (1974).
The first cause of action alleges that the defendants, in breach of obligations imposed pursuant to § 10(b) of the Exchange Act and Rules 10b-5 and 10b-10 thereunder and Article 3, Section 12 of the N .A.S.D. Rules of Fair Practice, failed to disclose "material facts about the compensation they received as brokers, including: (a) defendants' pecuniary interest in the automatic sweeps they execute on behalf of their customers; and (b) the extent of defendants' remuneration." (Compl.§ 47.)
To state a cause of action under Section 10(b) and Rule 10b-5, "a plaintiff must plead that in connection with the purchase or sale of securities, the defendant, acting with scienter, made a false material representation or omitted to disclose material information and that plaintiff's reliance caused [plaintiff] injury." Acito v. IMCERA Group, Inc., 47 F.3d 47, 52 (2d Cir.1995). Defendants contend that Press fails to state a claim pursuant to Fed.R.Civ.P. 12(b)(6) because it does not establish scienter; because the alleged fraud is not "in connection with the purchase or sale of a security"; and because the omissions alleged are not material.
A. Scienter
To plead scienter adequately, plaintiff must allege facts that give rise to a strong inference of fraudulent intent. Acito, 47 F.3d at 52; San Leandro Emergency Med. Plan v. Phillip Morris Cos., 75 F.3d 801, 813 (2d Cir.1996); Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d Cir.1994). A judge in this district has recently held, after thorough analysis of the statute, that under the Private Securities Reform Act of 1995, Pub.L. No. 104-67, 109 Stat. 737, a pleading of motive and opportunity alone is not sufficient to raise a strong inference of fraudulent scienter. In re Baesa Securities Litig., 1997 WL 379690 (S.D.N.Y. July 9, 1997). Under the plain language of the Reform Act, even if motive and opportunity are adequately plead, facts must still be alleged that give rise to a strong inference of fraudulent intent. [FN2] Therefore, the Complaint must set forth sufficient particulars to raise a strong inference that the Defendants acted with fraudulent scienter by not providing the Rule 10b-10 information in their monthly statements or confirmations.
FN2. The scienter requirement of the Reform Act does not appear to depart from Second Circuit precedent in that the Second Circuit has similarly required that the allegations of motive and opportunity to commit fraud give rise to the strong inference of fraudulent intent. See Acito v. IMCERA Group, Inc., 47 F.3d at 54 (finding allegation of motivation by officers to inflate stock prices in order to increase executive compensation not to give rise to a strong inference of fraudulent intent); San Leandro Emergency Plan, 75 F.3d at 814 (finding allegation of motive to maintain high credit rating and realization of large profit on stock sale not to give rise to strong inference of fraudulent intent); see also Baesa, 1997 WL 379690 at n. 3. End of footnote.
Rule 10b-10 provides
(a) Disclosure Requirement. It shall be unlawful for any broker or dealer to effect for or with an account of a customer any transaction in, or to induce the purchase or sale by such customer of, any security ... unless such broker or dealer, at or before completion of such transaction, gives or sends to such customer written notification disclosing: ....
(i) If the broker or dealer is acting as agent for such customer, for some other person, or for both such customer and some other person: ....
(D) The source and amount of any other remuneration received or to be received by the broker in connection with the transaction ....
17 C.F.R. § 240.10b-10. Rule 10b-10 was also amended in 1983 to provide for
(b) Alternative periodic reporting. A broker or dealer may effect transactions for or with the account of a customer without giving or sending to such customer the written notification described in paragraph (a) of this section if:
(1) Such transactions are effected ... in shares of any open-end management investment company ... that holds itself out as a money market fund ...; and
(2) Such broker or dealer gives or sends to such customer ... after the end of each monthly period ... a written statement disclosing ... any remuneration received or to be received by the broker or dealer in connection therewith.
Rule 10b-10 requires disclosure of "[t]he amount of remuneration received or to be received by the broker from such customer in connection with the transaction." 17 C.F.R. § 240.10b-10. The Defendants contend that as described by the allegations, the Rule 12b-1 fees are asset-based fees that are calculated based upon a percentage of a money market fund's aggregate net assets over time rather than on a transactional basis. The language of Rule 10b-10, however, does not require that the remuneration received must be calculated on a transactional basis, or in any other fashion, but only that it be "in connection with the transaction." Although the amount of the Fees may be based on aggregate balances kept in the funds over a certain period of time rather than on a per-transaction-basis, they are initiated by and, thus, received by the broker in connection with, a transaction, i.e., the purchase of shares in a money market fund.
In response to a letter from the Investment Company Institute ("ICI"), which wrote on behalf of the mutual fund industry, the SEC Staff issued a No-Action Letter dated March 19, 1979 stating that
we would not recommend enforcement action to the Commission under Rule 10b- 10, if a customer's confirmation of a transaction in a security registered pursuant to the Securities Act of 1933 and issued by a registered open-end management investment company did not disclose the sales load or any other charges in connection with the transaction, provided that the customer had received, at or before completion of the transaction, a current prospectus applicable to the security that disclosed the precise amount of the sales load or other charges or a formula that would enable the customer to calculate the precise amount of those fees. Of course, if a broker-dealer received remuneration which was not disclosed in the prospectus in the manner described above, that remuneration would be required to be separately disclosed on a confirmation.
SEC No-Action Letter, [1979 Transfer Binder] Fed. Sec. L. Rep. (CCH) § 82,041 at 81,656 (Mar. 19, 1979) ("1979 No-Action Letter," attached as Def. Reply Mem. Ex. A.). On March 16, 1994 the SEC issued a letter stating that it "believe [d] the broker-dealer should disclose its transaction-related compensation" in investment company transactions, despite prospectus disclosure; announced its intent to withdraw its March 19, 1979 No-Action Letter; and requested ICI to respond to the proposed withdrawal. SEC No-Action Letter, 434 Pa.Super. 670, 640 A.2d 476, 1994 WL 131086 (Mar. 16, 1994) (Def. Reply Mem. Ex. B.) Since the SEC has apparently not withdrawn it, the 1979 No-Action Letter still appears to be controlling, [FN3] and a defendant's compliance with the 1979 No-Action letter would be sufficient for the purposes of satisfying Rule 10b-10 and such compliance as a matter of law would not support an inference of fraudulent intent in a securities fraud pleading.
FN3. Neither of the two SEC No-Action Letters addressing the matter, discussed supra, makes a distinction for asset-based fees. End of footnote.
There is no allegation that defendants failed to furnish plaintiff with a current prospectus for either of the money market funds at or before the sweep of its account into a money market account as required by federal securities law. Thus, if the funds' prospectuses disclosed the "precise amount of the sales load or other charges or a formula that would enable the customer to calculate the precise amount of those fees," the Defendants would comply with the 1979 No-Action Letter, and, hence, Rule 10b-10 with respect to the alleged Fees.
An examination of the prospectuses involved demonstrates that there was not strict compliance with the 1979 No-Action letter. The Complaint alleges that Alliance pays to U.S. Clearing "at least 35 basis points, and in all likelihood considerably more." (Compl.§ 20.) Plaintiff attaches an AMR Fund Prospectus dated November 1, 1995, which provides that
Under a Distribution Services Agreement ..., the Fund makes payment to the Adviser at a maximum annual rate of .25 of 1% of the Fund's aggregate average daily net assets. For the fiscal year ended June 30, 1995, the Fund paid the Adviser at an annual rate of .21 of 1% of the average daily value of the Fund's net assets. Substantially all such monies (together with significant amounts from the Adviser's own resources) are paid by the Adviser to broker-dealers and other financial intermediaries for their distribution assistance ....
(Compl. Ex. B at 8.) Defendants also submit a "Statement of Additional Information" for AMR Fund dated November 1, 1995 ("AMR SAI"), which the AMR Fund prospectus incorporates by reference. The AMR SAI discloses that
[d]uring the fiscal year ended June 30, 1995, the Fund made payments to the Adviser for expenditure under the Agreement in amounts aggregating $4,167,754 which constituted .21% of 1% at an annual rate of the Fund's average daily net assets and the Adviser made payments from its own resources as described above aggregating $6,746,432. Of the $10,914,186 paid by the Adviser and the Fund under the Agreement, $115,156 was paid for advertising, printing and mailing of prospectuses to persons other than current shareholders; and $10,799,030 was paid to broker-dealers and other financial intermediaries for distribution assistance.
(Whitaker Aff. Ex. 1 at 17-18.) [FN4]
FN4. The AMR SAI is appropriately considered in this motion to dismiss because it is incorporated by reference in the AMR Prospectus. See White v. Melton, 757 F.Supp. 267, 272 (S.D.N.Y.1991). End of footnote.
Defendants have also submitted an APP Prospectus dated April 20, 1995, stating that
[u]nder a Distribution Services Agreement ..., each Portfolio pays the Adviser at a maximum annual rate of .45 of 1% of the Portfolio's aggregate average daily net assets. Substantially all such monies (together with significant amounts from the Adviser's own resources) are paid by the Adviser to broker-dealers and other financial intermediaries for their distribution assistance and to banks and other depository institutions for administrative and accounting services provided to the Portfolios. (Pietrzak Aff. Ex. A at 2, 8.) [FN5]
FN5. Because a key element of the first cause of action depends on what was disclosed by the prospectuses, the APP Prospectus, required by law to be filed with the SEC, is integral to the complaint and thus properly considered in this motion to dismiss. See Kramer v. Time Warner, Inc., 937 F.2d 767 (2d Cir.1991); Cortec Indus., Inc. v. Sum Holding, L.P., 949 F.2d 42 (2d Cir.1991). That the APP Prospectus is integral to the Complaint is apparent by the fact that the Complaint both references and attaches the AMR Prospectus.
The AMR Prospectus along with the AMR SAI disclose the receipt of fees by Defendants since they provide a precise amount of past charges paid to broker- dealers for the year ending June 30, 1995, i.e., $10,799,030. The AMR Prospectus and SAI fail, however, "to enable the customer to calculate the precise amount of those fees" as required by the 1979 No-Action Letter. While Defendants contend that post hoc disclosure is the only disclosure possible due to the way the payments are calculated, they do not give reason why the formulas to determine the amounts of such fees to broker-dealers could not be set forth with more particularity to enable the customer to estimate the amounts the broker receives for given aggregate amounts over given periods of time. Thus, the AMR Fund Prospectus and SAI do not appear to be in complete compliance with the 1979 No-Action Letter. For the same reasons, the APP Fund Prospectus is also not in complete compliance with the 1979 No-Action Letter.
The AMR Prospectus and SAI provide enough information, however, to negate any inference of fraudulent intent with respect to failure to disclose information regarding commissions or financial interests as might be required under Rules 10b-10, 10b-5, or Article 3, Section 12 of the N.A.S.D. Rules of Fair Practice. Accepting the Complaint's allegations as true, including that Alliance pays U.S. Clearing at least 35 basis points, given that the AMR Prospectus discloses a .25% fee plus "significant amounts" from the Adviser's own resources to be paid to broker dealers and given that the AMR SAI discloses quantitative amounts for the previous fiscal year, the Complaint fails to allege facts that give rise to the inference of fraudulent intent with respect to sweeps into the AMR Fund.
The APP Fund Prospectus discloses that a maximum of .45% in Fees is paid to the adviser and that substantially all of this money together with significant amounts from the adviser's own resources are paid "by the Adviser to broker- dealers and other financial intermediaries for their distribution assistance." The disclosure contradicts the claim of fraudulent intent with respect to the complaint's allegation of failure to disclose receipt of at least 35 basis points. Accordingly, the Complaint fails to allege facts giving rise to a strong inference of fraudulent intent. Because the allegations in the Complaint fail to show scienter with respect to sweeps into either the AMR or APP Funds, the first cause of action is dismissed. [FN6]
FN6. Because Defendants have failed to plead scienter, it is unnecessary to determine whether the alleged fraud was "in connection with the purchase or sale of a security" or whether the omitted information was material under Section 10(b)(5). End of footnote.
B. State Claims
Due to the dismissal of the federal claim against defendants, this Court declines to exercise supplemental jurisdiction over the state claims pursuant to 28 U.S.C. § 1367(c)(3). The second, third, and fourth claims for relief are thus dismissed.
C. Leave to Replead
Plaintiff, subsequent to Defendants' previous motion to dismiss, withdrew its original complaint, and submitted the Amended Class Action Complaint "[i]n light of the concerns expressed by the court at the oral argument in Strougo v. Bear Stearns & Co. et al., 95 Civ. 6532(RPP)." (Letter from Pl. to Court of Nov. 4, 1996, Pietrzak Aff. Ex. B.) Plaintiff has leave to file a Second Amended Complaint by August 25, 1997.
Conclusion
The first cause of action, for violation of Section 10(b), is dismissed pursuant to Fed.R.Civ.P. 12(b)(6). The second, third, and fourth causes of action are dismissed pursuant to 28 U.S.C. § 1367(c)(3).
IT IS SO ORDERED.
This page was last updated on September 26, 2001.