# In Re Catanella and EF Hutton and Co.

> District Court, E.D. Pennsylvania · April 9, 1984 · 583 F. Supp. 1388

URL: https://www.frixlaw.com/law-library/cases/1597541

## Case

- **Full name:** In Re CATANELLA AND E.F. HUTTON and COMPANY, INC. SECURITIES LITIGATION
- **Court:** District Court, E.D. Pennsylvania
- **Decided:** April 9, 1984
- **Citations:** 583 F. Supp. 1388; 1984 U.S. Dist. LEXIS 17796
- **Precedential status:** Published
- **Opinion:** Opinion by Giles
- **Judges:** Giles
- **Cited by:** 120 later opinions in the Frix Law Library

## Citator (automated)

- No negative treatment found by the automated citator. That is not the same as a confirmation that the case is good law; read the citing cases.
- Full citator and citing cases: https://www.frixlaw.com/law-library/cases/1597541

## How later opinions describe it (automated extraction)

- finding nearly identical language of a complaint “susceptible to the interpretation” that a broker offered and sold securities “to plaintiffs, rather than just purchasing stock on the open market for their accounts”
- finding plaintiff sufficiently pled a claim based on New Jersey common law fraud where “various misrepresentations and omissions are described [in exacting detail], accompanied by the substance of the statements, the identity of the speaker and why they are alleged to be fraud…
- holding plaintiff failed to plead an enterprise because “[n]o conceivable reading of the statutory definition would support a conclusion that securities accounts qualify as ‘enterprises’ ”
- stating that “Rule 9(b)’s particularity requirements prohibits reliance upon unsubstantiated conclusory allegations.”
- stating that “Rule 9(b)’s particularity requirements prohibit reliance upon unsubstantiated conclusory allegations.”

## Opinion text

MEMORANDUM AND ORDER
GILES, District Judge.
TABLE OP CONTENTS
SUBJECT PAGE
I. INTRODUCTION 1392
II. THE COMPLAINTS 1393
III. DISCUSSION 1397
A. Pleading Deficiencies 1397
1. Specificity and Rule 9(b) 1397
2. Immaterial, Impertinent or Scandalous Matter 1400
3. Simplicity and Rule 8 1401
B. Federal Securities Laws 1402
1. Section 10(b) 1402
(a) Scope of Prohibited Conduct 1403
(b) Churning 1405
(c) In Connection With 1407
(d) Causation 1413
2. Section 12(2) 1417
3. Investment Advisers Act of 1940 1418
4. Section 17(a) 1417
5. Vicarious Liability 4449
C. The Rico Claims 1422
1. The Statute 1422
2. Securities Related Issues 1424
3. Organized Crime 1426
4. Injury 1430
(a) Competitive Injury 1431
(b) Racketeer Enterprise Injury 1434
D. State Law Claims 1437
1. Pendent Jurisdiction 1437
2. Causation 1438
3. State Securities Statutes 1438
4. New Jersey Consumer Fraud Act 1441
I. INTRODUCTION
Before the court are motions to' dismiss in five securities fraud cases, consolidated for purposes of pretrial proceedings by the Judicial Panel on Multidistrict Litigation.
1
Although the allegations contained in the complaints vary slightly, each involve the conduct of Kenneth G. Catanella (“Catanella”), a securities broker employed by defendant E.F. Hutton and Company, Inc. (“Hutton”). Catanella is accused of a continuing course of fraud in connection with his handling of plaintiffs’ portfolios. The allegations run the gamut from churning to the purchase of unsuitable securities and the failure to disclose the risks inherent in certain transactions. In addition to misrepresentations and omissions directly impinging upon trading decisions, it is also averred that Catanella failed to disclose his role in a prior securities fraud action. Defendants Hutton and Granville are sued for failing to supervise Catanella adequately and under the related doctrine of
respondeat superior.
They are also characterized as “controlling persons” and aiders and abettors. Plaintiffs invoke sections 12(2), 15 and 17(a) of the Securities Act of 1933, 15 U.S.C. §§
m
(2), 77o, 77q(a) (1976), sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a) (1976) and the Investment Advisers Act of 1940, 15 U.S.C. §§ 80b-l — 80b-17
*1393
(1976) . Claims are also made pursuant to the Racketeer Influenced and Corrupt Organizations Act of 1970, (“RICO”), 18 U.S.C. §§ 1961-1968 (1976). Various counts based upon state law have been appended to the federal claims. In their motions to dismiss, defendants have assailed the legal sufficiency of virtually every cause of action. For the reasons which follow, the motions shall be granted in part and denied in part.
II. THE COMPLAINTS
When deciding a motion to dismiss, the court must take as true all well pled allegations and resolve all reasonable inferences drawn therefrom in the light most favorable to the nonmoving party.
See e.g., Miree v. DeKalb County,
433 U.S. 25 , 27 n. 2, 97 S.Ct. 2490 , 2492 n. 2, 53 L.Ed.2d 557 (1977) ;
Rogin v. Bensalem Township,
616 F.2d 680 , 685 (3d Cir.1980);
Bogosian v. Gulf Oil Corp.,
561 F.2d 434, 444 (3d Cir. 1977).
2
Mindful of this standard, I shall summarize the rather complex allegations contained in the complaints. In the interest of brevity, I shall address issues jointly where possible.
Each complaint begins by tracing the progress of Catanella’s brokerage career. After spending eight months as a trainee, he embarked on that career at Paine, Webber, Jackson & Curtis, Inc. (“Paine, Webber”) in 1969. Then, from December, 1972 until November, 1973, he was a registered representative and sales manager for Shearson, Hayden, Stone, Inc. (“Shear-son”). Taraborelli Complaint at ¶ 16; Shulik Complaint at ¶ 8.
3
In April of 1974, Catanella’s former customers from Paine, Webber and Shearson instituted suit against him and his former employers, claiming violations of a variety of federal and state securities laws.
4
After a bench trial, Catanella was found to have violated sections 10(b) and 15(c) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78o (c) (1976), various regulations and stock exchange rules. The trial court determined that Catanella had intentionally mishandled those plaintiffs’ accounts, making unauthorized and unsuitable purchases, failing to disclose the risks inherent in short term trading and recommending securities without justification or investigation. Catanella also churned the accounts, disregarded specific instructions and breached a variety of fiduciary duties. Taraborelli Complaint at ¶ 19. Paine, Webber and Shearson were held liable for,
inter alia,
failing to supervise Catanella.
Id.
Judgment was entered against the defendants for eight hundred and thirteen thousand dollars ($813,000.00) and the case was later settled for an amount very close to that figure.
Id.
at 1120.
The instant complaints also allege that Catanella had been terminated by Paine, Webber and Shearson, had been the subject of customer complaints and disciplinary proceedings, and had been previously fined for unauthorized trading. Catanella’s commission record had been quite high, a potential indicia of churning.
Id.
at 1121. Despite this dubious employment history, Hutton hired Catanella as a registered representative. It is averred that Hutton either knew all of these facts before hiring him or was reckless in its failure to so learn. Not only was Catanella hired, but he was also named Portfolio Manager, made a member of Hutton’s Director’s Advisory Council and elected Vice-President. These titles added to Catanella’s credibility, but were allegedly undeserved and misrepresented the level of his expertise.
Id.
at
*1394
11¶ 23-24. In an attempt to launch Catanella’s career at Hutton, a series of widely publicized seminars and lectures were sponsored by the firm. Famous market prognosticator, Joseph Granville was spotlighted at these lectures and Catanella was presented as a follower of the Granville method of investing. Gaugler Amended Complaint at H 8. These seminars were directly or indirectly responsible for bringing plaintiffs and Catanella together.
A.
The Gaugler Complaint
Edward Gaugler, a sixty two year old retired scientist, attended a Hutton seminar in Atlantic City. Both Granville and Catanella were in attendance, and the latter was dubbed the “Granville Oriented Broker in the Tri-State Area.”
Id.
at H 9. During the seminar, Gaugler was given an informational card, which he filled out, entitling him to a free Granville Newsletter. This card also provided Catanella with the ability to contact and solicit him as a potential customer, which he did. Gaugler explained that his investments to date had been conservative,
id.
at II11, and that he desired only a “businessman’s risk.”
Id.
at 22. It is alleged that Gaugler was unsophisticated in investments and this fact should have been clear to Catanella.
Id.
at 11¶ 3, 11. Catanella attempted to convince Gaugler to follow the Granville market approach, making it appear that he was in constant contact with Granville and that Granville approved of his trading decisions. He also represented that Hutton’s research facilities were utilized in reaching all trading decisions.
Id.
at HH 11-14.
The complaint avers numerous wrongdoings by Catanella and Hutton, including their failure to disclose the cash position in Gaugler's account thereby enabling Hutton to use the idle cash for its own benefit,
id.
at ¶ 17; failure to disclose that certain transactions were contrary to Granville’s advice,
id.
at ¶ 18; failure to disclose that Gaugler had not “gotten in” at the beginning of Granville’s strategy for a certain period,
id
at ¶ 23, and failure to disclose that Hutton’s research resources were rarely utilized in making trading decisions,
id.
at H 24. Defendants made unauthorized trades, purchasing securities that were far riskier than those desired by Gaugler. Catanella induced Gaugler to purchase options, representing himself to be experienced in that area. Gaugler was never apprised of the significant risks involved and after losing almost all of the capital invested, was told that Catanella had never before traded in options.
Id.
at MI 21-22. Contrary to their representations, when warranted by the situation, defendants did not place firm stop orders on behalf of Gaugler’s account.
Id.
at H 25. Gaugler claims that Catanella engaged in churning, yielding a turnover ratio in excess of seven to one,
id.
at ¶ 16, and failed to disclose that he was a defendant in the
Brown
suit. Hutton and Granville were aware of Catanella’s complicity or were reckless in their failure to so learn.
Id.
at MI 25F, 25H. Finally, Granville is accused of reassuring Gaugler that all was going well while the other defendants were raping his portfolio.
Id.
at H 19.
Gaugler sues under sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a) (1976); section 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a) (1976); section 206 of the Investment Advisers Act, 15 U.S.C. § 80b-6 (1976) and RICO. The complaint also contains state claims for breach of contract, breach of fiduciary duty, conversion, fraud, negligence, violation of the New Jersey Consumer Fraud Act, N.J.Stat. Ann. tit. 56 § 8-1 — 8-20 (West Supp.1983-1984), and the New Jersey Uniform Securities Law, N.J.Stat.Ann. tit. 49 § 3-47 — 3-76 (West Supp.1983-1984). The liability of Granville and Hutton is premised upon the “controlling persons” provision,
id.
at 117;
respondeat superior, id.
at II 28; failure to adequately supervise Catanella,
id.
at H 20 and aiding and abetting.
Id.
at 27.
Catanella and Hutton seek dismissal, assailing the complaint for not pleading fraud with sufficient specificity to satisfy Rule 9(b) of the Federal Rules of Civil Procedure. Alternatively, they seek a more definite statement under Rule 12(e). Defend
*1395
ants contend that Gaugler has failed to state a claim under section 10(b), arguing that the complaint is devoid of any allegations of material misrepresentations or omissions in connection with the purchase or sale of securities. Further, they insist that the complaint fails to state a cause of action under RICO and both New Jersey statutes. Defendants assert that count eleven, which contains details of the
Brown
action, including excerpts from the court’s findings, should be striken as “immaterial, impertinent or scandalous matter,” under Rules 11 and 12(f). Defendants also claim that certain portions of the complaint are violative of Rule 8. Finally, if the federal causes of action fail, Catanella and Hutton argue for dismissal of the pendent state claims.
In a separate motion, Granville moves to dismiss or for a more definite statement under Fed.R.Civ.P. 12(e). In addition to expressly joining the motion of Catanella and Hutton, Granville argues that the complaint does not support liability against him either as a controlling person or an aider and abettor.
B.
The Taraborelli Complaint
David Taraborelli brings suit on behalf of himself and all other persons who purchased from or sold securities to, Catanella from April 1, 1979 to the present. Taraborelli Complaint at ¶ 9.
5
Like the Gaugler complaint, it traces Catanella’s employment history and involvement in
Brown.
Again, Catanella is charged with churning, failing to disclose the risks of option and margin trading and engaging in unauthorized transactions, unsuited to the customer’s needs or desires. It is generally averred that he disseminated material false or misleading information to his customers.
Id.
at 1111 25, 26. Catanella and Hutton
6
are sued under sections 10(b) and 20(a) of the Securities Exchange Act of 1934, RICO, common law fraud, misrepresentation, negligence and both the Pennsylvania and New Jersey securities statutes. In their motion to dismiss, defendants raise arguments similar to those made in Gaugler. With respect to section 10(b), defendants argue that the requisite material misrepresentations or omissions are absent, that their actions did not cause plaintiffs’ losses, and were not “in connection with” the purchase or sale of a security. It is asserted that the fraud allegations were not pled with sufficient specificity and that the complaint fails to state a cause of action under RICO. Portions of the complaint are labeled scandalous and impertinent and defendants maintain that the failure of the section 10(b) claim would prove fatal to the section 20(a) claim. Finally, defendants contend that the complaint fails to state a cause of action under either the Pennsylvania or New Jersey statute, that causation is lacking and that all pendent claims should be dismissed if the federal claims are found wanting.
C.
The Shulik Complaint
Saul and Teresa Shulik met Catanella at one of the Hutton-Granville seminars. They were also unsophisticated investors and specifically advised him of their interest in safe and conservative investments. Shulik complaint at ¶ 18. Although Catanella agreed to abide by their wishes, he indicated that as amateurs, they ought to rely upon him to handle their portfolio. Initially, Catanella did purchase blue chip quality stocks as requested.
Id.
at 1122. However, a variety of circumstances led to the sale of most, if not all, of this high quality stock. First, Catanella convinced the Shuliks to open a margin account to allow them greater purchasing power. In response to plaintiffs’ inquiries about the high interest, risks involved and frequent transactions, Catanella assured the Shuliks that he was proceeding along the appropriate course.
Id.
at 1125. However, a large portion of the blue chip stock in the Shu
*1396
liks’ portfolio was sold in order to effectuate Granville’s advice to “go short,”
id.
at ¶ 27, a decision which resulted in substantial losses. In an attempt to recoup some of these losses, Catanella began to purchase a large volume of shares in a company called Texas International. All blue chip securities, except holdings in Exxon and Smith, Kline were sold to purchase blocks of Texas International stock.
Id.
at H 30. When the price began to decline, the Shuliks requested that Catanella sell while they could still profit, but once again Catanella reminded them that they had no experience in the field and should “leave everything to him.”
Id.
at ¶ 32. Ultimately, the price dropped so low that virtually the entire portfolio was sold to satisfy margin calls.
Id.
at 33-35. In addition to losing their initial investment of seventy-two thousand dollars ($72,000), they paid eleven thousand dollars ($11,000) in brokerage commissions and over thirteen thousand dollars ($13,000) in interest on their margin account.
Id.
at ¶ 36.
The Shuliks accuse defendants of churning, manipulating their margin account to generate interest, failing to disclose the risks involved in margin trading and purchasing securities without reasonable investigation or justification, considering their stated investment goals. The Shuliks point out that they relied upon Hutton’s reputation and Catanella’s representations about his experience. Given their lack of sophistication, they followed Catanella’s advice according him
de facto
control over their account.
Id.
at ¶ 45. In deciding to trust and rely upon Catanella, plaintiffs did not know of his role in
Brown.
The complaint alleges violations of sections 10(b) and 20(a), RICO, the Investment Advisers Act and the Pennsylvania and New Jersey securities statutes. Claims are also included for fraud, conversion, negligence and breach of contract. The motion to dismiss in this case raises virtually identical arguments, contending that the complaint fails to state a claim under section 10(b), RICO, the Investment Advisers Act and the Pennsylvania and New Jersey securities statutes.
D.
The Singer Complaint
Although Ronald Singer did not attend a Hutton-Granville lecture, he responded by telephone to a promotional advertisement and was subsequently contacted by Catanella. Singer Complaint at MI 16-17. He explicitly informed Catanella of his interest in only safe investments. Catanella promised to invest ninety percent (90%) of his money in conservative high quality securities, using only ten percent (10%) for more speculative ventures.
Id.
at ¶ 20. Catanella made a variety of representations about his experience and informational links, inducing Singer to open an account with him. Singer stated that he was investing the bulk of his assets, was unsophisticated, and was therefore relying on Catanella. He accorded the broker broad discretionary powers.
Id.
at ¶ 21. Contrary to the investor’s expectations, Catanella engaged in highly speculative maneuvering, selling short, on margin and purchasing options. He misrepresented the risks, failing to disclose,
inter alia,
that by trading on margin, Singer was actually gambling with more money on the table. He failed to explain how interest was computed, the extent to which Hutton benefitted from the margin account and the eventuality of margin calls. He also indicated that trading on margin was suitable for someone with Singer’s investment objectives.
Id.
at ¶ 26. However, the margin account was allegedly opened primarily to generate interest income for Hutton.
Id.
at H 27. Defendants also are accused of churning.
Id.
at II37. When the value of Singer’s portfolio began to decline, Catanella reassured him that he would handle everything and would “turn things around.”
Id.
at II30. To recoup, Catanella began purchasing only Texas International, an allegedly undervalued stock. The suitability of this volatile stock was misrepresented and, as mentioned above, its market price began to plummet. Margin calls led Singer to owe Hutton approximately twelve thousand dollars ($12,-000).
Id.
at 35. Allegations with respect to
Brown
also find themselves in this complaint. Singer invokes sections 10(b), 12(2),
*1397
15 and 20(a); RICO and the Pennsylvania and New Jersey securities statutes. The full panoply of state common law claims are also included.
Once again, the motions to dismiss attack the legal sufficiency of the securities and RICO claims. Defendants also contend that the churning allegations lack the specificity required under Fed.R.Civ.P. 9(b). Finally, defendants incorporate all arguments raised in the Taraborelli motion.
E.
The Rastelli Complaint
The Rastelli complaint is a virtual carbon copy of Singer. Consequently, the motion to dismiss asserts the same arguments raised in the Singer motion.
III. DISCUSSION
A.
Pleading Deficiencies
In addition to more substantive attacks, defendants argue that all of the complaints suffer from fatal pleading flaws. The allegations are assailed under Rules 8 and 9(b) of the Federal Rules of Civil Procedure. Moreover, portions of the complaints are characterized as “immaterial, impertinent or scandalous,” worthy of being stricken under Rules 11 and 12(f). I shall address these contentions
seriatim.
1.
Specificity and Rule 9(b)
Rule 9(b) of the Federal Rules of Civil Procedure requires allegations of fraud to be pled with particularity.
7
Defendants argue that plaintiffs’ averments are conclusory, lacking the factual specificity necessary to formulate an intelligent response. They cite plaintiffs’ failure to furnish the details typically required of newspaper reporters — the who, what, where, when and how of the misrepresentations and omissions. The allegations of scienter are condemned as faulty as are the charges of churning. Defendants contend that the RICO counts are predicated upon vacuous and deficient allegations of securities fraud. As an alternative to dismissal, defendants seek a more definite statement under Fed.R.Civ.P. 12(e).
Rule 9(b)’s particularity requirements prohibits reliance upon “unsubstantiated conclusory allegations.”
Juster v. Rothschild, Unterberg, Towbin,
554 F.Supp. 331, 332 (S.D.N.Y.1983) (quoting
Vetter v. Shearson Hayden Stone, Inc.,
481 F.Supp. 64, 65 (S.D.N.Y.1979).
Accord Decker v. Massey-Ferguson, Ltd,
681 F.2d 111, 115 (2d Cir.1982);
Segal v. Gordon,
467 F.2d 602, 607 (2d Cir.1972);
Mauriber v. Shearson/American Express, Inc.,
567 F.Supp. 1231, 1236 (S.D.N.Y.1983);
Kimmel v. Peterson,
565 F.Supp. 476, 481 , (E.D.Pa.1983);
Merrill Lynch, Pierce, Fenner & Smith v. DelValle,
528 F.Supp. 147, 149 (S.D.Fla.1981);
Goodman v. Moyer,
523 F.Supp. 33, 35 (E.D.Pa.1981). As the Second Circuit stated in
Segal ,
“10b-5 violations will not pass scrutiny if they do not allege with some specificity the statements allegedly constituting fraud.” 467 F.2d at 607 . The purpose for this rule is two-fold. It protects parties from frivolous allegations of fraud. As Wright and Miller noted; “[I]t is a serious matter to charge a person with fraud and hence no one is permitted to do so unless he is willing to put himself on record as to what the alleged fraud consists of specifically.” 5 C. Wright & A. Miller,
Federal Practice & Procedure,
§ 1298 at 413 (1969) (footnotes omitted). It also serves a notice function. To comply with the rule, a complaint must contain sufficient detail to apprise the defendants of the claims against them and allow them to formulate a meaningful response.
See e.g., Gottreich v. San Francisco Investment Corp.,
552 F.2d 866 (9th Cir.1977);
Kimmel,
565 F.Supp. at 481 ;
Kaufman v. Magid,
539 F.Supp. 1088, 1092-93 (D.Mass.1982);
Baselski v. Paine, Webber, Jackson & Curtis, Inc.,
514 F.Supp. 535, 540 (N.D.Ill.1981);
Zaretsky v. E.F. Hutton & Co., Inc.,
509 F.Supp. 68 , 74 n. 27 (S.D.N.Y.1981);
Posner v. Coopers & Lybrand,
92 F.R.D. 765, 768 (S.D.N.Y. 1981) ,
aff'd mem.,
697 F.2d 296 (2d Cir. 1982) . Although it is difficult to describe
*1398
abstractly the quantum of specificity required, the rule is generally deemed satisfied where the complaint details the time, place, substance of the alleged misrepresentations, as well as the identity of the individual perpetrating the fraud.
See e.g., Bennett v. Berg,
685 F.2d 1053, 1062 (8th Cir.1982),
aff'd en banc,
710 F.2d 1361 (8th Cir.1983),
cert. denied,
— U.S. -, 104 S.Ct. 527 , 78 L.Ed.2d 710 (1983);
Kaufman,
539 F.Supp. at 1093 ;
Baselski,
514 F.Supp. at 540 ;
Troyer v. Karcagi,
476 F.Supp. 1142, 1149 (S.D.N.Y.1979). However, as the
Baselski
court noted; “[t]he sufficiency of a pleading under this rule also varies with the complexity of the transaction. When the transactions are numerous and take place over an extended period of time, less specificity is required.” 514 F.Supp. at 540 (citations omitted). Furthermore, Rule 9(b) must be read in conjunction with Rule 8(a) which requires only a short and plain statement of the cause of action.
8
Therefore, the rule should not be applied with such draconian strictness as to undermine the liberal spirit of the Federal Rules of Civil Procedure.
Considering the complaints in light of the standards articulated above, I conclude that dismissal is not warranted. The Gaugler complaint sets out the churning allegations in exacting detail, including the names of the securities allegedly churned, the commissions generated, the frequency of trades and the turnover ratio.
9
Gaugler Amended Complaint at ¶ 16i-x. In addition, various misrepresentations and omissions are described, accompanied by the substance of the statements, the identity of the speaker and why they are alleged to be fraudulent. The only thing missing is the exact date on which each incident occurred. However, there is more than sufficient information to apprise defendants of the claims against them and aid in formulating a response. The Gaugler complaint does not offend Rule 9(b) and neither dismissal nor a more definite statement is warranted.
The Shulik, Rastelli and Singer complaints, while not as detailed as the amended complaint in Gaugler, still pass muster under Rule 9(b). They contain much more than the conclusory allegations of fraud that defendants portray. A course of fraudulent activity is chronicled, including a variety of misrepresentations and omissions, the substance of which is described in the complaints. The relative knowledge of the parties is outlined and the perpetrator of the fraud identified. The breadth of the allegations convinces me that the fraud aspects of these complaints are not “vexatious,” brought only to tarnish the defendants’ reputations. Although not paragons of specificity, I conclude that the allegations stated are sufficient to place defendants on notice and allow them to respond. As the court in
Mauriber
noted; “I find no greater merit in defendant’s remaining scattershot contentions that the complaint omits various details ____ The complaint is not deficient for failing to state every detail that might be a proper subject for interrogatories.” 567 F.Supp. at 1236 . I recognize, as did the court in
Mauriber ,
that the actual shaping of issues in complex cases takes place during the discovery process.
See also Christidis v. First Pennsylvania Mortgage Trust,
717 F.2d 96, 99-100 (3d Cir.1983).
*1399
However, I do note that the churning charges in these complaints are somewhat conclusory. The Shulik complaint states the amount of commissions paid to defendants. The Rastelli and Singer complaints assert only that plaintiffs’ portfolios were churned to generate commissions and in direct contradiction to plaintiffs’ investment instructions. Defendants argue that these allegations are insufficient under Rule 9(b) principally because they fail to identify those transactions alleged to be improper. Notwithstanding that some courts might, in their discretion, require more specificity to maintain a churning claim than is present here,
see Russo v. Bache Halsey Stuart Shields, Inc.,
554 F.Supp. 613, 617-18 (N.D.Ill.1982);
Vetter v. Shearson Hayden Stone, Inc.,
481 F.Supp. 64, 66 (S.D.N.Y.1979);
Fein v. Shearson Hayden, Stone, Inc.,
461 F.Supp. 137, 142-43 (S.D.N.Y.1978), I will not dismiss these portions of the complaints.
See e.g., Kaufman v. Magid,
539 F.Supp. 1088, 1095 (D.Mass.1982) (general allegations of churning, tracking definition held sufficient). As the
Baselski
court noted, where the transactions are numerous and stretch over an extended period of time, less specificity is required. 514 F.Supp. at 540 . Given the time frame involved in these complaints and the potentially large number of transactions involved, a requirement that plaintiff list each allegedly fraudulent purchase and sale would be unduly burdensome and undermine the liberal notice pleading embodied in the Federal Rules of Civil Procedure.
10
Accord Baselski,
514 F.Supp. at 541 n. 2. Moreover, unless they have been diligent record keepers, plaintiffs may lack, pre-discovery, detailed information necessary to list all transactions or calculate turnover ratios. The records containing that information are most likely in the possession of defendants. Although I do not sanction conclusory pleading and would prefer more detail, I decline to impose requirements that may bar otherwise deserving plaintiffs from vindicating their claims. Even assuming that plaintiffs do possess the necessary information, dismissal or requiring a more definite statement would serve little practical utility. Defendants have been accused of churning and have sufficient facts to admit or deny that allegation. Amendments to the complaints would only delay what already appears to be a protracted suit. As this court noted; “[o]nly through discovery will both sides gain the information required to assert their respective claims and defenses.”
Kimmel,
565 F.Supp. at 482 .
The Taraborelli complaint is the least specific of the five. Although the pleading sets forth in great detail Catanella’s involvement in
Brown
and the findings in that case, the other allegations of fraud are somewhat conclusory. The factual background is provided, including Hutton’s role in launching Catanella’s career with the aid of the Granville seminars. However, the ultimate allegations of fraud are sparse.
11
Plaintiffs’ response concedes that the requisite particularity is lacking, but argues that his claim of fraud is predicated only upon Catanella’s failure to disclose his role in
Brown. See
Plaintiff’s Memorandum of Law in Opposition to Defendant’s Motion to Dismiss the Complaint at 18. The other allegations of fraud, including churning and option and margin trading without dis
*1400
closing the inherent risks, are said to support the claim of fraud, rather than constitute it.
Id.
Frankly, I am perplexed how an allegation of churning relates to the failure to disclose the existence of a previous action. It seems apparent that these are separate and distinct instances of fraudulent conduct. However, I shall accept plaintiffs’ representation that the fraudulent behavior is limited to
Brown.
The averments surrounding
Brown
are pled with sufficient particularity under Rule 9(b). Given plaintiffs’ position, I need not reach the specificity of the other allegations of fraud and shall deny the motion to dismiss. However, this issue may arise again if I am called upon to decide a class certification motion. Should plaintiff desire at that time to include other instances of fraud, he will be required to furnish additional factual allegations.
12
Defendants’ motions to dismiss on specificity grounds are therefore denied.
13
2.
Immaterial, Impertinent or Scandalous Matter
Defendants move to strike portions of the complaints as “immaterial, impertinent or scandalous” under Fed.R.Civ.P. 12(f). The challenge focuses upon the RICO counts, which set out at length the details of the
Brown
action.
14
In particular, defendants attack the quotation of large excerpts from the court’s findings in
Brown.
It is argued that
Brown
has nothing to do with this action, is not material and is extremely prejudicial. In addition, defendants characterize the averments as an attempt to prove that Catanella acted in conformity with his prior conduct, an impermissible inference under Rule 404(b) of the Federal Rules of Evidence.
The standard for striking under Rule 12(f) is strict. One court has stated that “only allegations that are ‘so unrelated to plaintiffs’ claims as to be unworthy of any consideration as a defense’ should be striken.”
EEOC v. Ford Motor Co.,
529 F.Supp. 643, 644 (D.Col.1982) (quoting C. Wright & A. Miller,
Federal Practice and Procedure
§ 1380 at 784 (1969)). Similarly, immateriality under this rule has been defined as “any matter having no value in developing the issues of a case.”
Oaks v. City of Fairhope, Ala.,
515 F.Supp. 1004, 1032 (S.D.Ala.1981).
Defendants’ arguments overlook the fact that the
Brown
litigation is highly relevant in two major respects. Catanella’s previous involvement in securities fraud may help establish the “pattern of racket
*1401
eering” prong of RICO.
15
More importantly, the failure to disclose Catanella’s role in
Brown
is one of the alleged acts of fraud. The details surrounding the suit become crucial. For example, the more outrageous the fraud in
Brown,
arguably the more material becomes the failure to disclose. The actual resolution of the suit may also be highly probative with respect to Hutton’s level of knowledge. I do not interpret these allegations as an attempt to prove Catanella’s present liability because of the marked similarity between the activities. Quoting
ad nauseum
from the court’s findings might not have been necessary, however, the content of those findings is not “so unrelated to plaintiffs’ claims” as to warrant striking them under Rule 12(f). By so holding, I do not rule on the legal sufficiency of a section 10(b) claim premised upon the failure to disclose
Brown,
an issue which shall be analyzed
infra.
I decide only that, as a matter of pleading, dismissal is not appropriate.
3.
Simplicity and Rule 8
Defendants attack the RICO counts for their verbosity, arguing that Fed.R. Civ.P. 8 is thereby offended. Rule 8(a)(2) requires that a pleading contain “a short and plain statement of the claim showing that the pleader is entitled to relief____” This rule sets the liberal tone of the federal pleading requirements, in sharp contrast to the earlier formalistic code and writ pleading. Indeed, Rule 8(e)(1) states that “[e]ach averment of a pleading shall be simple, concise, and direct.
No technical forms of pleading or motions are required.”
Fed.R.Civ.P. 8(e)(1) (emphasis added). However, the Rule must be applied with some logic and common sense. The length of a pleading will depend upon a number of factors, not the least of which is the complexity of the case.
Accord Kaufman,
539 F.Supp. at 1092 .
The RICO counts, detailing the findings in
Brown,
are indeed prolix. However, as determined above, these allegations may be relevant, although very lengthy and redundant in spots. I shall not go through each count and determine which averments ought to remain and which are potentially extraneous. I agree with the sentiments expressed in
Kaufman :
The plaintiffs in this action are alleging the violation of numerous provisions in the federal securities laws, which are complex in their application. This makes “concise” pleading difficult.
What verbosity and repetition appears in the complaint does not, standing alone, justify dismissal under Rule 8.
Kaufman,
539 F.Supp. at 1092 (emphasis added). Accordingly, the RICO counts shall not be dismissed pursuant to Fed.R. Civ.P. 8.
In Gaugler and Shulik defendants also argue that the state law claims lack sufficient factual allegations to pass muster under Rule 8(a)(2). For example, the contract claim in Gaugler is faulted for failing to set forth when the contract was formed and the substance of its terms. Similarly, on the breach of fiduciary duty issue, plaintiffs allegedly fail to spell out the nature of the claimed duty. This argument misperceives the purpose of Rule 8. Striking complaints that fall short of perfection is the very practice which the Federal Rules sought to end. All that is required is a sufficient
factual
basis to place defendants on notice and allow them to frame a response. This has been satisfied here. The complaints detail the genesis and evolution of the parties’ relationship. It does not require extraordinary perception to recognize that both the contract and fiduciary duty claimed arose from the brokerage-customer relationship. The remaining state law claims are also predicated upon sufficient factual bases and shall not be dismissed.
*1402
B.
Federal Securities Laws
1.
Section 10(b)
Section 10(b)
16
of the Securities Exchange Act of 1934 and its implementing rule, 10b-5
17
broadly prohibit fraud in connection with the purchase and sale of securities. The fundamental purpose of the 1934 Act was “to substitute a philosophy of full disclosure for the philosophy of
caveat
emptor____”
Affiliated Ute Citizens of Utah v. United States,
406 U.S. 128, 151 , 92 S.Ct. 1456, 1471 , 31 L.Ed.2d 741 (1972) (quoting
SEC v. Capital Gains Research Bureau,
375 U.S. 180, 186 , 84 S.Ct. 275, 280 , 11 L.Ed.2d 237 (1963)). The Act is to be applied “not technically and restrictively, but flexibly to effectuate its remedial purposes.”
Affiliated Ute,
406 U.S. at 151 , 92 S.Ct. at 1471 (quoting
SEC v. Capital Gains Research Bureau,
375 U.S. 180, 195 , 84 S.Ct. 275, 284 , 11 L.Ed.2d 237 (1963)).
See also Superintendent of Insurance v. Bankers Life & Casualty Co.,
404 U.S. 6, 12 , 92 S.Ct. 165, 169 , 30 L.Ed.2d 128 (1971). Although drafted as an SEC enforcement provision, a private right of action “has been consistently recognized for more than 35 years. The existence of this implied remedy is beyond peradventure.”
18
Herman & Maclean v. Huddleston,
459 U.S.
375, 103 S.Ct. 683, 687 , 74 L.Ed.2d 548 (1983).
Judicial limitations which have been placed upon a section 10(b) claim also serve to define the elements of the cause of action. For example, in order to have standing to sue, a plaintiff must have either purchased or sold securities.
See Blue Chip Stamps v. Manor Drug Stores,
421 U.S. 723, 749 , 95 S.Ct. 1917, 1931 , 44 L.Ed.2d 539 (1975). The fraudulent conduct alleged must take the form of a misstatement, omission, manipulation or deception. The mere breach of a fiduciary duty is not actionable.
See Santa Fe Ind., Inc. v. Green,
430 U.S. 462, 477, 479-80 , 97 S.Ct. 1292, 1303-1304 , 51 L.Ed.2d 480 (1977). As the statutory language indicates, the fraud must be “in connection with” the purchase or sale. In misstatement and omission cases, the controverted fact must also be “material.” The definition of materiality in section 10(b) cases has been borrowed from the section 14(a) context. Quoting from
TSC Industries, Inc. v. Northway, Inc.,
426 U.S. 438, 449 , 96 S.Ct. 2126, 2132 , 48 L.Ed.2d 757 (1976), the Third Circuit describes materiality as “a substantial likelihood that, under all circumstances, the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder.”
19
*1403
Healey v. Catalyst Recovery of Pennsylvania, Inc.,
616 F.2d 641, 647 (3d Cir.1980).
A plaintiff must also prove that the fraudulent conduct was accompanied by “scienter.”
Ernst & Ernst v. Hochfelder,
425 U.S. 185, 193 , 96 S.Ct. 1375, 1380 , 47 L.Ed.2d 668 (1976). Although the
Ernst
court left the question open, this Circuit and others have held that reckless behavior is sufficient.
20
See e.g., Sirota v. Solitron Devices, Inc.,
673 F.2d 566, 575 (2d Cir.),
cert. denied,
459 U.S. 838 , 103 S.Ct. 86 , 74 L.Ed.2d 80 (1982);
McLean v. Alexander,
599 F.2d 1190, 1197-98 (3d Cir.1979);
Nelson v. Serwold,
576 F.2d 1332, 1337 (9th Cir.),
cert. denied,
439 U.S. 970 , 99 S.Ct. 464 , 58 L.Ed.2d 431 (1978);
Rolf v. Blyth, Eastman Dillon & Co., Inc.,
570 F.2d 38, 44-47 (2d Cir.),
cert. denied,
439 U.S. 1039 , 99 S.Ct. 642 , 58 L.Ed.2d 698 (1978);
Coleco Industries, Inc. v. Berman,
567 F.2d 569, 574 (3d Cir.1977),
cert. denied,
439 U.S. 830 , 99 S.Ct. 106 , 58 L.Ed.2d 124 (1978);
First Virginia Bankshares v. Benson,
559 F.2d 1307, 1314 (5th Cir.1977),
cert. denied, sub nom., Heller & Co. v. First Virginia Bankshares,
435 U.S. 952 , 98 S.Ct. 1580 , 55 L.Ed.2d 802 (1978);
Sunstrand Corp. v. Sun Chemical Corp.,
553 F.2d 1033, 1044-45 (7th Cir.),
cert. denied,
434 U.S. 875 , 98 S.Ct. 224 , 54 L.Ed.2d 155 (1977).
The final two elements of a section 10b cause of action are reliance and causation. These related concepts have generated a good deal of uncertainty,
see e.g., Sharp v. Coopers & Lybrand,
649 F.2d 175, 186-89 (3d Cir. 1981),
cert. denied,
455 U.S. 938 , 102 S.Ct. 1427 , 71 L.Ed.2d 648 (1982) (reliance);
Huddleston v. Herman & Mac-Lean,
640 F.2d 534, 547-50 (5th Cir.1981),
aff'd in part, rev’d in part,
459 U.S. 375 , 103 S.Ct. 683 , 74 L.Ed.2d 548 (1983) (reliance and causation). In analyzing these concepts, I shall endeavor not to add to the existing confusion.
Defendants’ section 10(b) arguments can be broken down into four major categories. First, defendants make a general
Santa Fe v. Green
argument, portraying the allegations as little more than breaches of fiduciary duties, devoid of the requisite material misstatements or omissions. The churning claims are also attacked as insufficient to state a cause of action. However, the more interesting and problematic issues presented focus upon the causation and “in connection with” elements.
(a)
The Scope of Prohibited Conduct
When minority shareholders challenged the Delaware statutory short form merger as a “device, scheme, or artifice to defraud,” the Supreme Court decided that it was time to put a halt to the seemingly endless expansion of the scope of section 10(b). Therefore, in
Santa Fe v. Green,
430 U.S. 462 , 97 S.Ct. 1292 , 51 L.Ed.2d 480 (1977), the Court held that in the absence of some form of deception, misrepresentation or non-disclosure, a breach of a fiduciary duty is not actionable under section 10(b).
Santa Fe,
430 U.S. at 475-77 , 97 S.Ct. at 1301-02 . No longer can the catch-all anti-fraud provision be used to redress claims of corporate mismanagement.
Id.
at 477 , 97 S.Ct. at 1302. Defendants endeavor to characterize the complaints as
Santa Fe
pleadings which allege little more than breach of a fiduciary duty or the failure to disclose such a breach.
21
Indeed, plaintiffs
*1404
are portrayed as poor losers — investors who are now crying over bad advice. After reviewing the complaints, I cannot agree.
Putting aside the churning allegations, I find allegations of material misrepresentations and omissions which elevate plaintiffs’ complaints beyond the reach of
Santa Fe .
The complaints allege, explicitly or inferentially, knowledge or recklessness on the part of defendants — thus fulfilling the scienter requirement.
22
See e.g.,
Gaugler Amended Complaint, ¶¶ 25F, 25H, 29; Taraborelli Complaint, If If
25, 26, 28;
Shulik Complaint 1140, 50; Singer Complaint, ¶ 39; Rastelli Complaint, 1135.
The failure to disclose Catanella’s role in the
Brown
litigation is an omission which, if material, would fall within the scope of section 10(b). In
Sutton v. Shearson Hayden Stone, Inc.,
490 F.Supp. 98 (S.D.N.Y. 1980), a broker’s failure to disclose that he had been the subject of previous customer complaints survived a motion to dismiss. Although the court seemed concerned about proof of materiality, there was no suggestion that this was simply a breach of fiduciary duty barred by
Santa Fe. Id.
at 101. Shearson Hayden paid $34,500 to satisfy irate and potentially litigious customers. Sutton, in turn, signed a promissory note for that amount. In contrast, the
Brown
litigation resulted in an $813,000 verdict. The court in
Sutton
found that disclosure of the customer complaints would serve the purpose of protecting investors — the goal of section 10(b).
Id.
at 101-03 . I agree. Moreover, the allegations here indicate that plaintiffs were not sophisticated and relied heavily upon Catanella. Thus, his track record of self-dealing, churning and mishandling of other portfolios would be highly material.
23
Catanella’s affirmative misrepresentation of his expertise in option trading, which induced Gaugler to purchase options, presents a similar situation. After losing all of the funds so invested, Catanella admitted that he had never before traded in options. Misrepresentation of expertise has been held actionable under section 10(b).
See Marbury Management, Inc. v. Kohn,
629 F.2d 705, 707-08 (2d Cir.1980),
cert. denied, sub. nom., Wood Walker & Co. v. Marbury Management, Inc.,
449 U.S. 1011 , 101 S.Ct. 566 , 66 L.Ed.2d 469 (1980) (trainee represented himself as “licensed registered representative” and “portfolio management specialist”).
Nor are the material omissions and misrepresentations limited to the
Brown
litigation. The Singer and Rastelli complaints contain detailed descriptions of all of the undisclosed risks and costs associated with margin trading. The mechanics of a margin account were not explained — plaintiffs were not told that they were actually plac
*1405
ing more money at risk. They were not informed about margin calls or the interest computation and were led to believe that margin trading was “prudent and cautious.” Singer Complaint, 1126; Rastelli Complaint, ¶ 26. The Shulik Complaint also contains averments of misrepresentations with respect to the risks of margin trading. Shulik Complaint, HU 23, 25, 26. Misrepresentations or omissions with respect to the risks inherent in margin trading are within the scope of section 10(b).
See e.g., Arrington v. Merrill Lynch, Pierce, Fenner & Smith,
651 F.2d 615 , 619 (9th Cir.1981);
Yancoski v. E.F. Hutton & Co., Inc.,
581 F.Supp. 88 at 92 (E.D.Pa. 1983). Catanella incorrectly advised Rastelli that the high volume of trading was appropriate, when in fact his account was being churned. This allegation also states a claim under section 10(b).
Accord Yancoski,
at 92. In all complaints, Catanella is accused of intentionally ignoring plaintiffs’ conservative investment goals, plunging money into speculative, high risk securities. This is a material misrepresentation, rather than merely a breach of fiduciary duty.
See Miley v. Oppenheimer & Co., Inc.,
637 F.2d 318, 326 (5th Cir.1981);
Yancoski ,
at 92.
See also Clark v. John Lamula Inv. Inc.,
583 F.2d 594, 599-601 (2d Cir.1978) (recommending unsuitable debentures violates section 10(b)). Finally, the complaints are replete with allegations of self-dealing and the general mishandling of plaintiffs’ accounts. Defendants’ goals were not to serve their customers, but rather to generate commissions and interest for themselves. Faced with a similar situation, the court in
Troyer
found material misrepresentations and omissions in defendant’s failure to disclose his self-dealing and mishandling of plaintiffs’ portfolio. 476 F.Supp. at 1146-47 . I agree with the approach taken in
Troyer .
The various allegations, taken together, form a course of fraudulent and deceptive conduct, transcending
Santa Fe v. Green
and adequately stating a claim under section 10(b).
24
(b)
Churning
Churning is a term of art which is actually a “synonym for ‘overtrading.’ ”
Armstrong v. McAlpin,
699 F.2d 79, 90 (2d Cir.1983) (citing Hazard & Christie,
The Investment Business
68 (1964)). It occurs when a broker engages in excessive trading for the purpose of generating commissions, without regard to the customer’s investment objectives.
See e.g., Costello v. Oppenheimer & Co., Inc.,
711 F.2d 1361, 1367 (7th Cir.1983);
Thompson v. Smith Barney, Harris Upham & Co., Inc.,
709 F.2d 1413, 1416 (11th Cir.1983);
Armstrong,
699 F.2d at 90 ;
Petrites v. J.C. Bradford,
646 F.2d 1033 , 1035 (5th Cir. 1981);
Miley v. Oppenheimer & Co., Inc.,
637 F.2d 318, 324 (5th Cir.1981);
Mihara v. Dean Witter & Co., Inc.,
619 F.2d 814, 820 (9th Cir.1980);
Williamsport Fireman Pension Boards I and II v. E.F. Hutton & Co., Inc.,
567 F.Supp. 140, 144 (M.D.Pa. 1983). Invoking the talismanic
Santa Fe
decision, the Gaugler defendants argue that the churning claim represents simply another chapter in state fiduciary duty law. Similarly, they argue that churning itself is insufficient to state a section 10(b) claim. Rather, churning allegations must be accompanied by averments of specific misrepresentations, omissions or acts of deception. Defendants also attack all complaints for the lack of detail with respect to the allegedly improper transactions. For the most part, these arguments were raised and rejected in the section discussing specificity.
It appears undisputed that churning
does
state a cause of action under section 10(b).
See e.g., Costello v. Oppenheimer & Co., Inc.,
711 F.2d 1361, 1368 (7th Cir.1983);
Thompson v. Smith Barney, Harris Upham & Co., Inc.,
709 F.2d
*1406
1413, 1416-17 (11th Cir.1983);
Follansbee v. Davis, Skaggs & Co., Inc.,
681 F.2d 673, 676 (9th Cir.1982);
Miley v. Oppenheimer,
637 F.2d 318, 324 (5th Cir.1981);
Mihara v. Dean Witter & Co., Inc.,
619 F.2d 814, 820 (9th Cir.1980);
Carras v. Burns,
516 F.2d 251, 258 (4th Cir.1975);
Landry v. Hemp-hill, Noyes & Co.,
473 F.2d 365 , 368 n. 1 (1st Cir.),
cert. denied,
414 U.S. 1002 , 94 S.Ct. 356 , 38 L.Ed.2d 237 (1973);
Hecht v. Harris Upham & Co.,
430 F.2d 1202, 1206-1207 (9th Cir.1970);
Mauriber v. Shear-son/American Express, Inc.,
567 F.Supp. 1231, 1237-38 (S.D.N.Y.1983);
Kaufman v. Magid,
539 F.Supp. 1088, 1095 (D.Mass. 1982);
Kaufman v. Merrill Lynch, Pierce, Fenner & Smith,
464 F.Supp. 528, 534 (D.Md.1978);
Dandorph v. Fahne Stock & Co.,
462 F.Supp. 961, 963 (D.Conn.1979);
Kravite v. Pressman, Frohlich & Frost, Inc.,
447 F.Supp. 203, 211 (D.Mass.1978);
Powers v. Frances I. DuPont & Co.,
344 F.Supp. 429, 431-32 (E.D.Pa.1972);
Lorenz y. Watson,
258 F.Supp. 724, 730 (E.D.Pa. 1966). As the court stated in
Follansbee :
It is settled that when a broker, unfaithful to the trust of his customer, churns an account in the brokers control for the purpose of enhancing the broker’s commission income and in disregard of the client’s interest, there is a violation of section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C.A. § 78a
et seq.,
and Securities and Exchange Commission Rule 10b-5.
681 F.2d at 676. In order to prove a churning claim, plaintiff must show that the broker exercised control over the account and that the trading was excessive.
25
See e.g., Costello,
711 F.2d at 1368 ;
Thompson,
709 F.2d at 1416-17 ;
Miley,
637 F.2d at 324 ;
Mihara,
619 F.2d at 821 ;
Kaufman,
539 F.Supp. at 1095 ;
Zaretsky v. E.F. Hutton & Co., Inc.,
509 F.Supp. 68, 74 (S.D.N.Y. 1981). Although courts seem to be in agreement with respect to these two elements, some have added the requirement that the broker act “with the intent to defraud or with willful and reckless disregard for the investor’s interest.”
Thompson,
709 F.2d at 1417 ;
Miley,
637 F.2d at 324 ;
Mihara,
619 F.2d at 821 .
26
However, this prong only appears to formalize the general scienter requirement necessary for all section 10(b) actions.
Although the prohibition on churning can probably be traced to the fiduciary responsibility a broker owes to its customers, as the above cited eases demonstrate, churning does rise to the level of a section 10(b) violation. The act of churning itself is a deception. As the
Costello
court noted; “as a scheme,
the essence of which is deception of a relying customer,
churning, as a matter of law, is considered a violation of section 10(b) and Rule 10b-5.”
Costello,
711 F.2d at 1368 (citations omitted) (emphasis added). Similarly, the Ninth Circuit stated “[t]he churning of a client’s account is, in itself, a scheme or artifice to defraud within the meaning of Rule 10b-5.”
*1407
Mihara,
619 F.2d at 821 .
Accord Yancoski,
at 91. In
Armstrong v. McAlpin,
699 F.2d 79 (2d Cir.1983), the district court had dismissed the churning claim for failing to allege an accompanying misrepresentation or omission. In reversing that decision, the court stated that “churning, in and of itself, may be a deceptive and manipulative device under section 10(b), the scienter required by section 10(b) being implicit in the nature of the conduct. The district court’s reliance upon
Santa Fe Industries v. Green, supra,
430 U.S. 462 , 97 S.Ct. 1292 , 51 L.Ed.2d 480 , was misplaced.”
Armstrong,
699 F.2d at 91 (citations omitted). I agree that the utilization of a customer’s account to generate omissions, without regard to the customer’s investment objectives, is “deceptive” within the meaning of section 10(b). To require a plaintiff to prove something in addition to the elements of control and excessiveness would be redundant and would contravene the overriding purpose behind the Securities and Exchange Act of 1934 — the protection of the investing public.
Defendants’ other arguments with respect to churning are made in the guise of pleading deficiencies under Rule 9(b) of the Federal Rules of Civil Procedure. I have already rejected the suggestion that a plaintiff must list all allegedly tainted transactions and calculate the turnover ratio. Although not as detailed as defendants might wish, the complaints do contain allegations of broad discretionary control and excessive trading in light of conservative investment objectives.
See e.g.,
Shulik Complaint, ¶¶ 19, 39, 44, 45; Singer Complaint, ¶¶ 21, 24; Rastelli Complaint, ¶¶ 21, 24. Moreover, paragraph 16 of the Gaugler Complaint sets forth in unassailable detail the names of the securities churned, the frequency of trading, the commissions paid and the estimated turnover ratio. Therefore, I conclude that churning claims are sufficient to survive a motion to dismiss.
(c)
In Connection With
Section 10(b) and Rule 10b-5 proscribe fraud “in connection with the purchase or sale of any security.” 15 U.S.C. § 78j (1976); 17 C.F.R. § 240 .10b-5 (1983). Defendants contend that many of plaintiffs’ allegations do not arise “in connection with” an actual purchase or sale. Although the failure to disclose
Brown
is the focal point of this argument, defendants cite the failure to disclose the risks of margin trading, churning, unsuitable purchases and other averments falling into the general category of mishandling plaintiffs’ accounts.
27
Defendants reason that these allegations reflect upon the choice of, or confidence in a broker, rather than the decision to buy or sell a particular stock. According to defendants, the latter satisfies the “connection” element, while the former does not. I do not agree.
Despite voluminous caselaw in the section 10(b) area, the “in connection with” element has received little judicial attention. The concept does not lend itself to definition and its application has generated more than its share of confusion. The only Supreme Court precedent,
Superintendent of Insurance of New York v. Bankers Life & Cas. Co.,
404 U.S. 6 , 92 S.Ct. 165 , 30 L.Ed.2d 128 (1971), provides little practical guidance. In
Bankers Life,
defendants essentially used the assets of a corporation, Manhattan Casualty Company, to acquire total ownership. Defendants purchased all of the stock of Manhattan using a check drawn at a financial institution. At the time the check was written, defendants had no funds on deposit there. After taking over Manhattan and installing a president, defendants induced the Board to sell some of its United States Treasury Bonds. The proceeds of the sale were used to cover the check with which the stock had been purchased. 404 U.S. at 7-8 . Noting that “[sjection 10(b) must be read flexibly, not technically and restrictively,”
id.
at 12 , 92 S.Ct. at 169, the Court stated that “there was a ‘sale’ of a security and since fraud was used ‘in connection with’ it, there is a
*1408
redress under § 10(b)----”
Id.
Although the Court did not explicitly define the “in connection with” element, it did explain that “Manhattan suffered an injury as a result of deceptive practices
touching
its sale of securities ____”
Id.
at 12-13, 92 S.Ct. at 169. (emphasis added). Because of this phrase,
Bankers Life
is universally cited for the proposition that the connection requirement will be satisfied if the alleged fraud “touches” the purchase or sale.
See, e.g., Arrington v. Merrill Lynch, Pierce, Fenner & Smith,
651 F.2d 615 , 619 (9th Cir.1981);
McGrath v. Zenith Radio Corp.,
651 F.2d 458, 467 (7th Cir.),
cert. denied,
454 U.S. 835 , 102 S.Ct. 136 , 70 L.Ed.2d 114 (1981);
Alley v. Miramon,
614 F.2d 1372 , 1378 n. 11 (5th Cir.1980);
Ketchum v. Green,
557 F.2d 1022, 1026 (3d Cir.)
cert. denied,
434 U.S. 940 , 98 S.Ct. 431 , 54 L.Ed.2d 300 (1977);
Yancoski v. E.F. Hutton & Co., Inc.,
581 F.Supp. 88 at 92 (E.D. Pa.1983);
Williamsport Firemen Pension Boards I and II v. E.F. Hutton & Co., Inc.,
567 F.Supp. 140, 143 (M.D.Pa.1983);
Chemical Bank v. Arthur Anderson & Co.,
552 F.Supp. 439, 451 (S.D.N.Y.1982);
Somogyi v. Butler,
518 F.Supp. 970, 985-86 (D.N.J.1981).
Bankers Life
raises the question what constitutes “touching” a securities transaction. Although many courts have taken a broad view of this element, there exists a paucity of viable standards. The Fifth Circuit has noted that “[t]he plaintiff ... need not establish a direct or close relationship between the fraudulent transaction and the purchase or sale____”
Alley v. Miramon,
614 F.2d 1372 , 1378 n. 11 (5th Cir.1980).
Accord Brown v. Ivie,
661 F.2d 62, 65 (5th Cir.1981),
cert. denied,
455 U.S. 990 , 102 S.Ct. 1614 , 71 L.Ed.2d 850 (1982). The
Alley
court went on to state that the requirement is “satisfied when the proscribed conduct and the sale are part of the same fraudulent scheme.” 614 F.2d at 1378 n. 11. In
Chemical Bank v. Arthur Anderson & Co.,
the court explained that
Bankers Life
and its progeny “require a nexus, albeit not a direct or close relationship, between the allegedly fraudulent conduct and the sale of securities.” 552 F.Supp. at 451 . This Circuit has “attempted to etch more-finely the contours of the ‘in connection with’ clause,” noting that other courts “[ajlmost without exception ... have found compliance ... even where fraudulent conduct is implicated only tangentially in a securities transaction.”
See Ketchum v. Green,
557 F.2d 1022, 1026-27 (3d Cir.),
cert. denied,
434 U.S. 940 , 98 S.Ct. 431 , 54 L.Ed.2d 300 (1977). However, rather than offering a standard, the
Ketchum
court observed that the ultimate determination is a factual one, best approached on a case by case basis.
Id.
at 1027 .
*1312
Each plaintiff was completely unaware of the falsity or misleading nature of the statements or omissions as set forth above in Paragraph 18 and of the fact that each security was unregistered, until approximately 1982.
*1408
Ketchum
involved a corporate power struggle. The plaintiffs were the Chairman of the Board and President of Babb, Inc., holding between them approximately forty-five percent of the stock of the company. Babb was a closely held corporation and stock could only be owned by employees. Defendants, other members of the Board, induced plaintiffs to support their slate of candidates without disclosing their plan to oust plaintiffs. After the incumbent directors were unanimously re-elected, the Board jointly proposed and elected their own candidates for the positions of chairman and president, removing plaintiffs as officers. Plaintiffs’ employment was then terminated and they were asked to surrender their stock pursuant to the corporation’s stock retirement plan. 557 F.2d at 1023-24 . The court found that the fraud was not “in connection with” the forced sale of plaintiffs’ securities. Characterizing the dispute as a corporate foray, the court noted that the actual securities transaction was tangential to the relief requested. Plaintiffs apparently were more concerned with recovering their seats and invalidating the elections.
28
Id.
at 1027 .
*1409
There, the court found the proximity between the fraud and the securities transaction to be more attenuated than in
Bankers Life.
As the court stated; “[i]nstead of being merely one step away from a securities deal, the supposed deception here is somewhat removed from the ultimate transaction. Indeed, there are a substantial number of intermediate steps between the fraud and the accomplishment of the forced sale of plaintiffs’ shares____”
Id.
at 1028 .
29
The court also expressed concern over the potential federalization of state law under section 10(b).
30
Id.
at 1029 . There is another distinction between
Ketchum
and
Bankers Life,
which was implicit in the court’s opinion. In
Bankers Life,
the securities transaction was an integral part of the fraudulent scheme. Yet in
Ketchum ,
the fraud was aimed at removing plaintiffs from the corporation. The forced sale was merely an incidental result of that scheme.
One year after deciding
Ketchum ,
this Circuit once again addressed the “in connection” issue in
Cramer v. General Tele. & Electronics Corp.,
582 F.2d 259 (3d Cir. 1978),
cert. denied,
439 U.S. 1129 , 99 S.Ct. 1048 , 59 L.Ed.2d 90 (1979). The plaintiffs challenged allegedly fraudulent commission payments made to a group of foreign investors. The arrangement arose out of GTE’s sale of its controlling interest in a foreign company. The buyers did not have sufficient funds with which to purchase that interest, so GTE financed part of the price by paying the purchasers a commission on future equipment sales. Concluding that the payment of commissions was “in connection with” the sale of GTE’s ownership interest, the court stated that: “GTE’s promise to pay commissions on equipment sales was not a separate agreement. Rather, that promise was an essential part of GTE’s original agreement to sell its interest in the foreign company.” 582 F.2d at 271. Without further analysis or citation to
Ketehum,
the court concluded: “[sjince the commission payments were inextricably linked to GTE’s sale of its ownership interest ..., we think the district court erred in concluding that the alleged fraud was not alleged to be in connection with the sale of a security.”
31
Id.
The fraud was not, as in the typical situation, the inducement for the securities transaction. Rather, the securities transaction was the inducement for the fraud. The financing problems surrounding the sale of ownership led GTE to arrange the allegedly fraudulent commission plan.
Analyzing the allegations in light of the scant principles articulated above, I conclude that the connection requirement has been satisfied. Defendants’ failure to disclose
Brown
“touches” all of the allegedly fraudulent securities transactions. Plaintiffs here were all unsophisticated investors. They were introduced to Catanella through E.F. Hutton, a well-known and well respected brokerage house. They were told about his qualifications and expertise and subsequently opened accounts.
*1410
They trusted Catanella and routinely followed his advice. In some cases, discretionary accounts were opened. Therefore, Catanella was in a position to choose the securities purchased and sold for plaintiffs’ portfolios. He had
de facto,
if not formal control, over the accounts. It was this control which allowed him to defraud plaintiffs by churning, buying unsuitable securities, failing to disclose risks and the like. If the plaintiffs knew that Catanella had previously defrauded investors, and the extent of that fraud, it defies logic to conclude that he would have been granted the kind of control which allowed him to perpetrate the fraud. Plaintiffs may have chosen not to deal with Catanella at all. Therefore, I find a .nexus between that initial failure to disclose
Brown
and all subsequent fraudulent transactions performed by Catanella.
I do not accept defendants’ contention that the failure to disclose
Brown
is too remote from the transactions. In
Bankers Life,
the sale of the bonds was an integral part of a complex scheme of fraud. Here, the initial fraud in failing to disclose
Brown
played an integral role in an ongoing scheme of fraudulent securities transactions. As the Fifth Circuit stated, the connection element is satisfied where “the proscribed conduct and the sale are part of the same fraudulent scheme.”
Alley,
614 F.2d at 1378 n. 11. The failure to disclose
Brown
was not only part of “the same fraudulent scheme,” but enabled defendants to package and sell Catanella as expert and untarnished in his brokerage experience.
The failure to disclose the risks of margin trading has been deemed fraud “in connection with” the purchase and sale of securities.
See Arrington v. Merrill Lynch, Pierce, Fenner & Smith,
651 F.2d 615 , 619 (9th Cir.1981);
Yancoski v. E.F. Hutton & Co., Inc.,
581 F.Supp. 88 at 92 (E.D.Pa.1983). This omission induced plaintiffs to open margin accounts and there is a nexus between that fraud and the securities purchased on margin. Defendants were informed that plaintiffs were desirous of safe investments. Although the failure to disclose did not necessarily result in the purchase of a specific security, it did cause plaintiffs to purchase more securities than they otherwise would have. Thus, plaintiffs unwittingly exposed themselves to more potential liability because of the increased trading a margin account permits. The failure to disclose certainly “touches” the securities so purchased.
In
Savino v. E.F. Hutton & Co., Inc.,
507 F.Supp. 1225 (S.D.N.Y.1981), the court faced a similar question. Defendants there allegedly misrepresented the risks of option trading. In holding the connection element satisfied, the court explained:
This alleged misrepresentation pertained directly to the underlying securities bought and sold for the Savino accounts. The Court is well aware of the recent admonition by the Court of Appeals for this Circuit that “[n]ot every ‘risky’ investment rises to the level of fraud because the risk is insufficiently disclosed.” * * * * * *
On the other hand, a claim is stated where, as here, the defendants, knowing that the risk involved in an investment is unacceptable to plaintiffs, allegedly deliberately misrepresented or omitted to state their opinion of the level of risk involved.
507 F.Supp. at 1241 (citations omitted). The observation applies with equal force to the allegations surrounding the purchase of unsuitable securities. When defendants knowingly ignore plaintiffs’ investment objectives and purchase speculative securities without apprising plaintiffs of the risk, a section 10(b) claim is stated. The fraud perpetrated “touches” and is “in connection with” the purchase of those unsuitable securities. Similarly, I find that churning is a fraudulent device which “touches” securities transaction. Many cases are cited in the previous section for the proposition that churning states a section 10(b) claim. While none of these cases discuss the connection element, none suggest potential problems with this requirement. The reason for this silence is fairly obvious. Churning denotes excessive trading. Thus,
*1411
by definition, churning is fraud “in connection with” the purchase or sale of a security.
32
Defendants contend that none of the activities discussed above are “in connection with” a securities transaction. They attempt a distinction between fraud which impacts upon the choice of a broker and that which influences the decision to buy or sell a particular security. They argue that the latter satisfies the connection requirement, the former does not. Defendants’ contention traces its roots to
Troyer v. Karcagi,
476 F.Supp. 1142 (S.D.N.Y.1979), a case upon which they rely heavily.
33
Although
Troyer
does contain some restrictive language, its application does not appear faithful to the narrow view of section 10(b) that it purports to articulate. Plainly put, the court says one thing and does another. Moreover, to the extent that
Troyer
does stand for the dichotomy advanced by defendants, I am unable to agree with its reasoning or result.
The facts of
Troyer
are fairly typical. The broker, Karcagi, made various representations to the Troyers, who were unsophisticated investors. These representations induced the Troyers to open discretionary accounts with Karcagi. Through an alleged course of mishandling and self-dealing, the Troyers lost approximately seventy-five percent (75%) of their rather substantial investment. 476 F.Supp. at 1146 . The court determined that the complaint survived a motion to dismiss “because it contained] allegations of a material misrepresentation or omission by Karcagi in connection with the purchase or sale of a security.”
Id.
The fraud revolved around the failure to disclose self-dealing and the misrepresentation of Karcagi’s intent to manage the account for his own, rather than Troyer’s benefit.
Id.
Applying the standard established in
SEC v. W.J. Howey Co.,
328 U.S. 293 , 66 S.Ct. 1100 , 90 L.Ed. 1244 (1946), the court determined that the discretionary accounts were “investment contracts” and therefore “securities.”
Id.
at 1147-48. Thus, the misrepresentations which induced the Troyers to open the accounts were made “in connection” with the purchase of those accounts, which were “securities.”
Id.
at 1148-49. In addition, the court took a very expansive view of what constitutes “purchasing” a discretionary account. There was a “purchase” each time a new account was opened, and also each time new funds were deposited into already existing accounts.
*1412
Troyer,
476 F.Supp. at 1148 . Therefore, any misrepresentations or omissions which induced the Troyers to invest new funds constituted fraud “in connection with” the “purchase” of a “security.”
In the alternative, the court explored whether the fraud was “in connection with” the purchase or sale of the underlying securities contained in the discretionary accounts. It is the resolution of this issue upon which defendants rely. At first the court suggested a negative answer, articulating the distinction drawn by defendants. The court explained:
The alleged misrepresentations concerning Karcagi’s investment performance and his intentions affected the investors’ confidence in a person selected by them to be their fiduciary rather than influencing their decision to purchase or sell particular securities. The purpose of Rule 10b-5,
i.
e., to promote “the maintenance of free and open securities markets nurtured in a climate of fair dealing” is not therefore sufficiently served.
476 F.Supp. at 1149 (citations omitted). The court then inexplicably and in contradiction to the above-quoted language concluded:
Hence, under the Troyers’ alternative theory of fraud in connection with purchases or sales of the underlying securities traded by Karcagi in the discretionary accounts,
a Rule 10b-5 cause of action is adequately alleged as to instances of the purchase or sale of securities under circumstances where Karcagi failed to disclose self-interest,
but not as to other purchases or sales where Karcagi induced the Troyers to grant him the discretion to make the purchases or sales by generalized representations.
Id.
(emphasis added). If I read the second passage correctly, the
Troyer
court essentially held that a claim was stated with respect to the purchase or sale of the underlying securities where Karcagi failed to disclose his self-dealing. Yet, Karcagi’s failure to disclose self-dealing did not impact upon the Troyer’s decision to buy or sell a particular stock, but rather, their trust and confidence in their broker. Thus, the court stated, but apparently declined to apply, the distinction between choosing a security and a broker. Moreover, as to purchases or sales resulting from Karcagi’s control over the account, induced by “generalized representations,” many of these would be actionable under the theory that the account itself is a security. Misrepresentations or omissions which induced plaintiffs to “purchase” a discretionary account would be covered by the first prong of
Troyer .
Given the broad definition of “purchase,” the Troyers were fairly well protected. The motion to dismiss was ultimately denied.
It is anomalous that the
Troyer
court suggested the distinction in light of its ultimate determination that the failure to disclose self-interest may be “in connection with” a securities transaction.
34
The instant case does not involve the mere retention of securities, although it does, to an extent, involve the retention of Catanella as broker. The fraud alleged here includes activities such as churning, margin trading without disclosing the risks and the purchase of unsuitable securities. All of these involve the purchase or sale of stocks. There is actually a supreme irony in defendants’ reliance upon
Troyer .
In those cases where plaintiffs opened or “purchased” discretionary accounts,
Troyer
ensures coverage to the allegation of most concern to defendants. The failure to disclose the
Brown
litigation induced plaintiffs to “purchase” their discretionary accounts and is clearly fraud “in connection with” the purchase of a security. More-
*1413
over, it is entirely possible that Troyer’s two step analysis affords more, rather than less protection under section 10(b).
The distinction suggested by
Troyer
and championed by defendants is also at odds with precedent and the purpose behind the 1934 Act. As a practical matter, the distinction between choosing a broker and choosing securities may well be meaningless. Where a broker is given control of the client’s portfolio, the choice of a broker is tantamount to the choice of securities. Defendants’ argument would push deceptive practices, such as churning, beyond the reach of the statute, simply because they might not impact upon the decision to purchase or sell a particular stock.
35
This conflicts with controlling caselaw and common sense. Similarly, the failure to disclose risks or a prior litigation would be out of reach, despite the fact that a requirement of full disclosure is the very heart of section 10(b).
36
Finally, this distinction ignores the admonition of the Supreme Court in
Bankers Life
that section 10(b) “must be read flexibly, not technically and restrictively.” 404 U.S. at 12 , 92 S.Ct. at 169. Although it is less exacting, I prefer the formulation of
Bankers Life
and progeny. Since I have concluded that the allegations “touch” and “are part of the same fraudulent scheme” as the purchase and sale of securities, the motion to dismiss on this issue shall be denied.
(d)
Causation
Defendants’ final section 10(b) argument focuses upon the
Brown
litigation and the thorny issue of causation. Plaintiffs, especially the purported class representatives in Taraborelli,
37
endeavor to link all their losses to defendants’ failure to disclose
Brown.
They reason that had they known about Catanella’s involvement, they would not have dealt with him or given him broad discretion over their accounts. Catanella would not, therefore, have had the opportunity to churn, buy unsuitable securities or engage in the panoply of fraudulent conduct alleged. Defendants contend that this initial failure to disclose
Brown
did not technically “cause” plaintiff’s injuries. Rather, the losses were the result of independent intervening causes, such as fluctuations in the market, wholly unrelated to Catanella. If market forces drive the price of a stock downward,
everyone
who purchased would be injured. Plaintiffs would have sustained the same losses had they purchased that particular security through a different broker. Plaintiffs retort that they would not have purchased that security
but for
their affiliation with Catanella. These arguments underscore the complexity of, and provide
*1414
focus to, the issue — the meaning of “proximate causation” in a section 10(b) case.
Causation actually has three facets. To analyze the arguments presented here, a clear understanding of the distinctions between them is necessary. The first is the “in connection with” requirement highlighted in the previous section. Although not typically analyzed in terms of “cause and effect,” this element requires some form of relationship between the alleged fraud and the purchase or sale of a security. The second type, referred to as “transaction causation,” asks whether “the violations in question caused the appellant to engage in the transaction in question.”
Schlick v. Penn-Dixie Cement Corp.,
507 F.2d 374, 380 (2d Cir.1974),
cert. denied,
421 U.S. 976 , 95 S.Ct. 1976 , 44 L.Ed.2d 467 (1975).
See also Valente v. Pepsico, Inc.,
454 F.Supp. 1228, 1246 (D.Del.1978). The final kind is “loss causation,” which requires a showing “that the misrepresentations or omissions caused the economic harm.”
Schlick,
507 F.2d at 380 .
See also Marbury Management, Inc. v. Kohn,
629 F.2d 705 , 720 & n. 6 (2d Cir.) (Meskill, J., dissenting), ce
rt. denied sub nom. Wood Walker & Co. v. Marbury Management, Inc.,
449 U.S. 1011 , 101 S.Ct. 566 , 66 L.Ed.2d 469 (1980). Transaction causation focuses upon whether the misrepresentation induced the plaintiff to buy the security, while loss causation looks at whether the misrepresentation was responsible for plaintiffs pecuniary injury.
Transaction causation is the “but for” requirement — “but for” the misrepresentation or omission, plaintiff would not have acted.
38
Stripped of fancy nomenclature, transaction causation
is
the reliance element in a section 10(b) case.
See e.g., Wilson v. Comtech Telecommunications Corp.,
648 F.2d 88 , 92 n. 6 (2d Cir.1981);
Huddleston v. Herman & MacLean,
640 F.2d 534 , 549 & n. 24 (5th Cir.1981),
aff'd in part, rev’d in part on other grounds,
459 U.S. 375 , 103 S.Ct. 683 , 74 L.Ed.2d 548 (1983);
Schlick,
507 F.2d at 380 and n. 11. An example will illustrate this relationship. A plaintiff contends that
but for
a misrepresentation in an offering circular, she would not have purchased certain securities. Not only does this satisfy the transaction causation prong, but it also inferentially shows that plaintiff read and
relied
upon the misrepresentation. Unfortunately, courts often use the phrases “reliance” and “causation” interchangeably, without specifying which type of causation they mean.
39
See generally Wilson,
648 F.2d at 92 n. 6. As this Circuit has noted; “[rjeliance is therefore one aspect of the ubiquitous requirement that losses be causally related to the defendants’ wrongful acts.”
Sharp v. Coopers & Lybrand,
649 F.2d 175, 186 (3d Cir.1981),
cert. denied,
455 U.S. 938 , 102 S.Ct. 1427 , 71 L.Ed.2d 648 (1982).
See also T.J. Raney & Sons, Inc. v. Fort Cobb, Okl. Irr. Fuel Auth.,
717 F.2d 1330 , 1332 (10th Cir.1983) (reliance as causal nexus between plaintiff’s injury and defendant’s conduct);
In re Ramada Inns Securities Litigation,
550 F.Supp. 1127, 1130 (D.Del.1982) (same).
In an omission case, a plaintiff is required to prove a negative in order to show transaction causation or reliance. That is, something material not said caused the action or inaction. Put another way, if the plaintiff had known, he would not have acted. Such a plaintiff would be unable to point to a misrepresentation in an offering circular and contend that it was read, relied and acted upon. To obviate this problem, courts have substituted materiality for reliance. In
Affiliated Ute Citizens v. United States,
406 U.S. 128 , 92 S.Ct. 1456 , 31 L.Ed.2d 741 (1972), the Supreme Court held that proof of materiality coupled with a duty to disclose would establish reliance, or as the Court phrased it, “causation in fact.” 406 U.S. at 153-54 , 92 S.Ct. at 1472.
*1415
Therefore, in an omission ease, transaction causation, which is actually reliance, can be inferred from materiality.
See generally Madison Consultants v. Federal Deposit Ins. Corp.,
710 F.2d 57 , 65 n. 6 (2d Cir. 1983);
Sharp,
649 F.2d at 187-88 ;
Shores v. Sklar,
647 F.2d 462, 468 (5th Cir.1981) (en banc);
Continental Grain, Etc. v. Pacific Oilseeds, Inc.,
592 F.2d 409 , 412 n. 1 (8th Cir.1979).
See also Healey v. Catalyst Recovery of Pennsylvania, Inc.,
616 F.2d 641, 649 (3d Cir.1980) (causation problems disposed of by applying materiality test).
40
Given the definition of materiality, something that there is “a substantial likelihood that a reasonable [investor] would consider important
...,” see TSC Industries, Inc. v. Northway, Inc.,
426 U.S. 438, 449 , 96 S.Ct. 2126, 2132 , 48 L.Ed.2d 757 (1976), this rebuttable presumption of reliance makes good legal sense.
Typically, it is the transaction causation prong that is a stumbling block for plaintiffs in section 10(b) cases.
See Wilson,
648 F.2d at 92 n. 7. Consider for example, the plaintiff who challenges a misrepresentation in an offering circular, but admits never having read it.
See e.g., Shores v. Sklar,
647 F.2d 462 (5th Cir.1981) (en banc). However, the failure to disclose a previous lawsuit is factually unique and the implications for causation are similarly unique. Defendants do not, and probably could not reasonably, attack the transaction causation of the failure to disclose
Brown. But for
the omission, plaintiffs would not have employed Catanella as their broker in the first place. Nor would Catanella have been accorded the unbridled discretion over their accounts which permitted him to engage in the allegedly fraudulent activities. Plaintiffs relied upon Catanella’s expertise and E.F. Hutton’s good name and reputation. Treating this is an omission case, reliance or transaction causation is inferred from materiality. As I indicated above, there is a substantial likelihood that plaintiffs would have considered Catanella’s role in
Brown
to be important in deciding whether to give him
carte blanche
over their accounts. Thus, the transaction causation requirement has been satisfied, at least for purposes of surviving a motion to dismiss.
However, defendants’ primary argument focuses upon loss causation — the nexus between the failure to disclose
Brown
and the actual monetary injury sustained. Often referred to as “proximate cause,” this concept has received far less discussion in the cases than transaction causation. In
Huddleston,
the Fifth Circuit explained:
The plaintiff must prove not only that, had he known the truth, he would not have acted, but in addition that the untruth was in some reasonably direct, or proximate, way responsible for his loss. The causation requirement is satisfied in a Rule 10b-5 case
only if the misrepresentation touches upon the reasons for the investment’s decline in value.
If the investment decision is induced by misstatements or omissions that are material and that were relied on by the claimant, but are not the proximate reason for his pecuniary loss, recovery under the Rule is not permitted.
640 F.2d at 549 . (citations omitted) (emphasis added).
41
The court gave the following example of a material misrepresentation which was not the proximate cause of the injury:
[A]n investor might purchase stock in a shipping venture involving a single vessel in reliance on a misrepresentation that the vessel had a certain capacity when in fact it had less capacity than was represented in the prospectus.
*1416
However, the prospectus does disclose truthfully that the vessel will not be insured. One week after the investment the vessel sinks as a result of a casualty and the stock becomes worthless. In such circumstances, a fact-finder might conclude that the misrepresentation was material and relied upon by the investor but that it did not cause the loss.
Id.
at 549 n. 25. It was the sinking of the vessel that caused the value of the stock to plummet, not the misrepresentation of its capacity. Similarly, with respect to the unauthorized and unsuitable securities purchased by Catanella, it was the intervention of market forces that caused plaintiffs’ losses. The failure to disclose
Brown,
like the misrepresentation of the ship’s capacity, may well have induced the purchase of the stock, but the acts of fraud were remote and wholly unrelated to the securities’ decline in value. Under the reasoning of
Huddleston,
therefore, an independent intervening cause, such as a fluctuation in' the stock market, will break the chain of causation.
Accord Fryling v. Merrill Lynch, Pierce, Fenner & Smith, Inc.,
593 F.2d 736, 743-44 (6th Cir.1979) (no causation where market conditions, rather than fraud, responsible for losses).
However, there are two cases which lend support to plaintiff’s position. In
Sutton v. Shearson Hayden Stone, Inc.,
490 F.Supp. 98 (S.D.N.Y.1980), a brokerage firm was sued for failing to disclose that one of its brokers had been the subject of numerous customer complaints. Shearson investigated these complaints and entered into monetary settlements to placate the angry investors.
Id.
at 100 . The customer complaints involved allegations of misconduct almost identical to those charged in the
Sutton
lawsuit. The court concluded without explanation that “Shearson’s failure to disclose these ... customer complaints proximately caused the damage sustained in ... [plaintiff’s] portfolio.”
Id.
at 101 . However, the absence of any “loss causation” analysis makes
Sutton
less than persuasive authority.
In the second case,
Marbury Management, Inc. v. Kohn,
629 F.2d 705 (2d Cir.),
cert. denied sub nom., Wood Walker & Co. v. Marbury Management, Inc.,
449 U.S. 1011 , 101 S.Ct. 566 , 66 L.Ed.2d 469 (1980), a trainee at a brokerage house misrepresented himself as a licensed, registered representative and a “portfolio management specialist.” Securities were purchased based upon the predictions of this trainee. Recognizing that the misrepresentations as to his qualifications did not cause the securities purchased to decline in value, the court nevertheless held that causation was established.
Id.
at 708. The basis for the court’s decision is not clear, but it apparently rested, in part, upon somewhat antiquated principles of common law “proximate causation.”
See id.
at 709-10. However, the court did not resolve the loss causation issue it raised, explaining in a footnote:
Differentiating transaction causation from loss causation can be a helpful analytical procedure only so long as it does not become a new rule effectively limiting recovery for fraudulently induced securities transactions to instances of fraudulent representations about the value characteristics of the securities dealt in. So concise a theory of liability for fraud would be too accommodative of many common types of fraud, such as the misrepresentation of a collateral fact that induces a transaction.
Id.
at 710 n. 3. In avoiding the loss causation problem, the court opted for what it considered to be the “just” result. However, I am constrained to agree with the vehement dissent that the majority decision was “more righteous than right____” 629 F.2d at 717 (Meskill, J., dissenting), and that “[i]n straining to reach a sympathetic result, the majority overlooked] a fundamental principle of causation____”
Id.
at 716-17 . In an approach strikingly similar to the one subsequently employed in
Huddleston,
Judge Meskill noted that “Kohn’s exaggeration of his expertise played no role in the economic collapse of the various stocks he touted.”
Id.
at 717. He explained further that:
As applied to the sale of stock precipitated by misstatements, these principles of causation are satisfied only where the misrepresentation touches upon the rea
*1417
sons for the investment’s decline in value. Thus, where one is induced to purchase securities in reliance upon a claim which, however deceitful, is immaterial to the operative reason for the pecuniary loss, recovery under a theory of fraud is precluded by the inability to prove the requisite causation.
Id.
at 718 (citations omitted). I find the view articulated by Judge Meskill and the
Huddleston
court to be logical and consistent with the definition of loss causation. A contrary view would render meaningless the distinction between transaction and loss causation, thereby writing the proximate cause requirement out of a section 10(b) cause of action. To find causation despite an intervening causative factor would transform the perpetrator of the fraud into “an insurer of the investment, responsible for an indefinite period of time for any and all manner of unforeseen difficulties which may eventually beset the stock.”
Mar-bury,
629 F.2d at 718 (Meskill, J., dissenting). Therefore, I conclude that defendants’ failure to disclose
Brown
was not the proximate cause of plaintiffs’ losses where the ebbs and flows of the stock market intervened.
42
A slightly different question is presented by the other claims, such as churning and the failure to disclose the risks of margin trading. There, the injuries sustained are not determined by the external forces of the market. Nor do the losses hinge upon the decline in the value of a given security. Rather, the damages are measured by the extent of excessive commissions generated by the churning or the interest accrued on the margin accounts. To be sure, failure to disclose
Brown
was a substantial factor in the control Catanella gained over plaintiffs’ accounts, giving him the opportunity to churn or engage in the other alleged acts of fraud. However, that merely satisfies the cause-in-fact or transaction causation requirement. These injuries did not flow directly from the failure to disclose the prior lawsuit. The acts of churning and failing to disclose the risks of margin trading, like the fluctuation in the market or the sinking of the vessel, were the intervening factors which caused plaintiffs’ harm. Therefore, as a matter of law, the failure to disclose
Brown
could not have been the proximate cause of the injuries suffered by plaintiffs.
43
By so holding, defendants’ activities are not condoned, but the limits of section 10(b) are merely recognized. Plaintiffs are not bereft of a remedy. All, save the Taraborelli plaintiffs, have asserted claims based upon the more immediate acts of fraud— the churning, the failure to disclose the risks of margin trading, the unsuitable purchases and the like.
44
Moreover, the factual allegations pertaining to
Brown
shall not be stricken from the complaint. Although they did not state an independent section 10(b) claim, they may be relevant to issues such as scienter, Hutton’s vicarious liability or state based common law theories of liability.
2.
Section 12(2)
Plaintiffs in the Singer and Rastelli complaints also invoke section 12(2) of the Securities Act of 1933, 15 U.S.C. § 77 /(2).
45
Defendants seek dismissal of
*1418
these claims, arguing that the complaints fail to establish the privity required by the statute. In their role as “broker,” defendants contend that they purchased and sold securities on behalf of plaintiffs, rather than selling securities that they owned to plaintiffs. Plaintiffs do not dispute that privity is an element of a section 12(2) cause of action,
46
but insist that the requisite buyer-seller relationship is alleged in the complaint. Indeed, each complaint avers that “[i]n connection with
the offer and sale of securities to plaintiff
Catanella made numerous untrue statements of material facts ____” Singer Complaint at II44; Rastelli Complaint at 1140 (emphasis added). Although this allegation may simply parrot the statutory language, on a motion to dismiss, I must draw all inferences in favor of the non-moving party. Plaintiffs argue, and I must agree, that the phrase is susceptible to the interpretation that Catanella offered and sold Hutton’s securities
to
plaintiffs, rather than just purchasing stock on the open market
for
their accounts. I am, therefore, unable to conclude “beyond doubt that the plaintiff can prove no set of facts ... which would entitle him to relief.”
Conley v. Gibson,
355 U.S. 41, 45-46 , 78 S.Ct. 99, 101-102 , 2 L.Ed.2d 80 (1957). Thus, the motion to dismiss must be denied. However, plaintiffs’ section 12(2) action shall be limited to those transactions where privity can be established.
3.
The Investment Advisers Act of 1940
The Gaugler and Shulik complaints also purport to state causes of action under the Investment Advisers Act of 1940, 15 U.S.C. § 80b-l — 80b-17 (1976). Defendants argue that these claims must be dismissed. I agree.
The allegations in Gaugler are directed at defendant Granville under section 206 of the Act, 15 U.S.C. § 80b-6 (1976). Gaugler Complaint at 111153-55.
*1419
However, in
Transamerica Mortgage Advisors, Inc. v. Lewis,
444 U.S. 11 , 100 S.Ct. 242 , 62 L.Ed.2d 146 (1979), the Supreme Court refused to imply a private right of action under section 206. 444 U.S. at 21-24 , 100 S.Ct. at 248-249 . The Shulik Complaint does not specify the section of the Act relied upon. Shulik Complaint at ¶¶ 57-59. To the extent that they endeavor to invoke section 206,
Transamerica
will bar their cause of action as well. Moreover, although
Transamerica
did hold that there is a right of action under section 215, 15 U.S.C. § 80b-15, this is a limited right, allowing a plaintiff to seek recission and restitution or an injunction to prevent the continued operation of the contract. 444 U.S. at 19 , 100 S.Ct. at 247 . If section 215 were applicable to plaintiffs’ claims, it would be of little aid to them in their quest for monetary damages. Furthermore, the allegations in Shulik are directed at Catanella and Hutton. As defendants correctly point out, they are not “investment advisors” under the Act. Section 202(11) defines an investment Adviser as:
any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities; but does not include ...
(C) any broker or dealer whose performance of such services is solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation therefor;
15 U.S.C. § 80b-2(ll) (1976). There is no allegation that Catanella’s advice was anything other than incidental to his brokerage functions or that he received special compensation for that advice.
See generally Kaufman v. Merrill Lynch, Pierce, Fenner & Smith, Inc.,
464 F.Supp. 528, 537-38 (D.Md.1978). The same is true for Hutton. Thus, plaintiffs have failed to state a cause of action for monetary damages and have failed to sue appropriate defendants under the Investment Advisers Act. The counts under the Act shall be dismissed.
4.
Section 17(a) of the Securities Act of 1933
The Gaugler complaint contains a count brought pursuant to section 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a) (1976). Defendants have not moved to dismiss this claim. However, in light of my decision in
Kimmel v. Peterson,
565 F.Supp. 476 (E.D.Pa.1983), I raise the issue
sua sponte.
In
Kimmel,
I held that there is no implied private right of action under section 17(a).
See Kimmel,
565 F.Supp. at 482-88 . In this, the court does not stand alone.
See e.g., Alloy v. Miller,
No. 83-4780 slip op. at 14 (E.D.Pa. February 8, 1984);
Hudson v. Capital Management Intern., Inc.,
565 F.Supp. 615, 625-27 (N.D.Cal.1983);
Massaro v. Vernitron Corp.,
559 F.Supp. 1068, 1078 (D.Mass.1983);
Basile v. Merrill Lynch, Pierce, Fenner & Smith, Inc.,
551 F.Supp. 580, 585-87 (S.D.Ohio 1982);
Keys v. Wolfe,
540 F.Supp. 1054, 1060 (N.D.Tex.1982),
aff'd in relevant part, rev’d on other grounds,
709 F.2d 413 (5th Cir.1983);
Kaufman v. Magid,
539 F.Supp. 1088, 1097-98 (D.Mass.1982).
See also Kimmel,
565 F.Supp. at 482 -83 and n. 6.
5.
Vicarious Liability
Catanella and Hutton seek to dismiss claims asserted against them under the “controlling persons” provisions — section 15 of the Securities Act of 1933, 15 U.S.C.
% 11 o
(1976) and section 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78t(a) (1976). Defendants contend that since plaintiffs have failed to state a cause of action under section 10(b), secondary or vicarious liability cannot attach.
47
However, the assumption upon which this argument is premised is faulty, as I have determined that there are section 10(b) claims sufficient to survive a motion to dismiss in
*1420
all cases except Taraborelli. Since a claim for primary liability has been adequately stated, the assertion of derivative liability cannot be dismissed on this basis.
48
In a separate motion, defendant Gran-ville moves to dismiss the claims against him, all of which are based upon theories of vicarious liability. Specifically, the Gaugler complaint labels him a “controlling person” under section 20(a) and an aider and abettor. Liability against Granville is also asserted under the doctrine of
respondeat superior.
In essence, the complaint accuses Gran-ville of bolstering Catanella’s reputation and then reassuring Gaugler of the wisdom of Catanella’s investments. His behaviour is characterized as “hand-holding.” It is claimed that Granville knew or was reckless in failing to learn about the fraud being perpetrated. Gaugler Complaint at
n
19, 29. The following specific activities are alleged in the complaint. Granville was present at the Hutton seminar attended by Gaugler in Atlantic City. He joined Catanella in representing the latter as the “Granville Oriented Broker in the Tri State Area.” He stated that Hutton “fully endorsed the Granville Market Theory.”
Id.
at 11 9. During the course of their association, Catanella frequently telephoned Gran-ville in Gaugler's presence. Granville spoke directly to Gaugler, allaying any fears he might entertain.
Id.
at 12. In addition, Granville called during Catanella’s radio show to endorse Catanella publicly and lead the listeners to believe that he approved Catanella’s trading decisions.
Id.
at H 13. A tape recorded conversation between Granville and former Treasury Secretary William Simon was played to impress Gaugler and other investors. This discussion focused upon Simon’s interest in the Granville strategy.
Id.
at 1115.
49
There is also a general allegation that Granville and Hutton failed to supervise Catanella adequately “contrary to their duties as controlling persons.”
Id.
at H 20. Finally, it is averred that Granville knew or was reckless in failing to learn about the facts surrounding the
Brown
litigation.
Id.
at 1125H. Granville argues that those allegations do not state a claim.
50
Respondeat superior
is not applicable to this case, factually or legally. This Circuit has held that, as a matter of law, the doctrine should not be used to impose vicarious liability under the securities laws.
Rochez Brothers, Inc. v. Rhoades,
527 F.2d 880, 885-86 (3d Cir.1975)
(Rochez
II).
See also Sharp v. Coopers & Lybrand,
649 F.2d 175, 183 (3d Cir.1981). The
Rochez
court reasoned that applying
respondeat superior
would circumvent the good faith defense contained in section 20(a). As the court explained, “imposing secondary liability would not advance the legislative purpose of the 1934 Act and in fact would also undermine the Congressional intent by emasculating section 20(a).”
Rochez
II, 527 F.2d at 885 . The court envisioned exceptions to this rule, such as in the case of broker-dealers, where “a stringent duty to supervise employees does exist.”
Id.
at 886 . Thus, Hutton could be held liable for Catanella’s acts under
respondeat superior.
However, Granville was not Catanella’s employer and no “stringent duty to supervise” existed. Thus, the broker-dealer exception is inapposite. This also underscores the factual problem with applying
respondeat superior
even in the absence of
Rochez.
The doctrine is based upon the agency concept that the principal or master will be responsible for the acts of the agent or servant. Granville was neither a principal nor agent vis-a-vis Catanella or Hutton. At
*1421
best, he was an independent participant. He appeared at the Hutton seminars only to gain followers and subscriptions to his market newsletter. Even assuming that an exception from
Rochez
could be carved out to cover this situation, common law principles of
respondeat superior
simply do not apply in this factual setting. Therefore, the claim shall be dismissed.
Section 20(a) of the Securities Exchange Act of 1934 is the vehicle through which secondary liability can be imposed upon those who “control” a primary violat- or. That section provides:
Every person who, directly or indirectly,
controls any person liable under any provision of this chapter or of any
rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the
controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.
15 U.S.C. § 78t(a) (1976) (emphasis added). A definition of “control” is conspicuously absent from the statute. In
Rochez,
the court opined that “Congress deliberately did not define ‘control’ thus indicating its desire to have the courts construe the applicable provisions of the statute along with the evidence adduced at trial.” 527 F.2d at 890 . The court recognized that the SEC defines control as “the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of a person____”
Id.
(quoting 17 C.F.R. § 240.12 (b)-2(f)).
While the Gaugler complaint states that Granville was a controlling person vis-a-vis Catanella and Hutton,
see
Gaugler Complaint at ¶ 7, it does not contain any factual averments which would support that assertion. The factual allegations in the complaint demonstrate indisputably that Gran-ville could not be a controlling person as a matter of law. With respect to Hutton, he was not a high ranking employee or officer with the power to direct its policies or management. Indeed, Granville was not an officer, director or employee of Hutton in any respect. His appearances at the seminars were his only connections with Hutton and those were motivated by his own self-interest — the profit gained from increased newsletter subscriptions. There is no basis in the complaint from which it can be adduced that Granville controlled Hutton.
Nor do the facts in the complaint give rise to the inference that Granville “controlled” Catanella. No relationship existed, employment or otherwise, that would allow Granville to exert influence over Catanella. The only link between the two was Catanella’s purported adherence to the Granville market method. The complaint plainly states that Catanella did not always follow Granville’s advice, despite representations to the contrary to Gaugler. Gaugler Complaint at ¶ 8. Thus, the plaintiff concedes that Catanella exercised independent judgment.
51
The claims against Granville based upon section 20(a) shall be dismissed.
The final issue, Granville’s liability as an aider and abettor, warrants a different result. Liability as an aider-abettor is not dependent upon the individual’s status or relationship with the primary violator. This theory imposes liability upon one who knowingly participates or aids in a securities violation.
See generally Rochez
II,
*1422
527 F.2d at 886 , Three elements must be present before liability can attach. There must be an underlying securities violation, the aider-abettor must have knowledge of the violation and must substantially assist or participate in the wrongdoing.
See Monsen v. Consolidated Dress Beef Co., Inc.,
579 F.2d 793, 799 (3d Cir.1978),
cert. denied,
439 U.S. 930 , 99 S.Ct. 318 , 58 L.Ed.2d 323 (1979);
Gould v. American-Hawaiian Steamship Co.,
535 F.2d 761, 779 (3d Cir.1976);
Rochez,
527 F.2d at 886 ;
Landy v. FDIC,
486 F.2d 139, 162-63 (3d Cir.1973),
cert. denied,
416 U.S. 960 , 94 S.Ct. 1979 , 40 L.Ed.2d 312 (1974).
Accord Armstrong v. McAlpin,
699 F.2d 79, 91 (2d Cir.1983);
SEC v. Seaboard Corp.,
677 F.2d 1289 , 1296 (9th Cir.1982);
Herm v. Stafford,
663 F.2d 669, 684 (6th Cir.1981);
ITT, An International Investment Trust v. Cornfeld,
619 F.2d 909, 922 (2d Cir.1980);
Rolf v. Blyth, Eastman Dillion & Co., Inc.,
570 F.2d 38, 47-48 (2d Cir.1978).
For purposes of this motion, I shall assume that an underlying securities violation has been established. With respect to the second element, the complaint alleges that Granville acted intentionally or recklessly. Gaugler Complaint at ¶ 29. Although recklessness will satisfy the general scienter requirement under section 10(b), it is unlikely that it is sufficient in the aiding and abetting context. In
Monsen ,
the Third Circuit stated that “[kjnowledge of the underlying violation is a critical element in proof of aiding-abetting liability, for without this requirement financial institutions, brokerage houses, and other such organizations would be virtual insurers of their customers against security law violations.” 579 F.2d at 799 .
Cf: Armstrong v. McAlpin,
699 F.2d 79, 91 (2d Cir.1983) (recklessness enough only if aider-abettor owes fiduciary duty to plaintiff; otherwise knowledge needed). However, since the complaint also pled knowledge, by way of intentional conduct, I must assume, for purposes of a motion to dismiss, that the second prong has also been satisfied. The issue remaining is whether Granville “substantially assisted” or “participated” in the fraudulent conduct. The complaint does not allege that Granville actually aided in the churning or the various omissions and misrepresentations. However, construing all reasonable inferences in favor of plaintiff, the complaint is susceptible to an interpretation of substantial assistance on the part of Granville. Knowing about Catanella’s escapades, Granville nevertheless continued to placate and reassure Gaugler, thus allaying potential fears or suspicions. This allowed Catanella to continue, undisturbed, in his course of fraudulent conduct. It is not clear at this early stage whether plaintiff can prove this scenario or a similar one — more factual development is needed. I am, however, unable to conclude, as a matter of law, that the complaint fails to state a claim against Granville on a theory of aiding and abetting.
C.
The RICO Claims
Defendants advocate dismissal of the claims brought pursuant to the civil remedy provision of the Racketeer Influenced and Corrupt Organizations Act of 1970, 18 U.S.C. §§ 1961-1968 (1976) (“RICO”). Four arguments are advanced — two of which actually depend upon how I resolved the underlying securities issues. Defendants contend that since the federal securities claims are legally deficient, no “pattern” of “racketeering activity” has been alleged. It is also asserted that the lack of “loss causation” in the securities sense precludes a finding that the injuries occurred “by reason of” a RICO violation. The other two arguments have become rather standard civil RICO defenses': the missing link to organized crime and the failure to allege an injury “by reason of” a violation of section 1962.
1.
The Statute
Title IX of the Organized Crime Control Act of October 15,1970, Pub.L. No. 91-452, 84 Stat. 941, better known as RICO, was enacted in an effort to quell the potence and persistence of organized crime.
52
As illustrated by its findings, Congress was
*1423
particularly concerned with organized crime’s steady infiltration into legitimate business:
The Congress finds that (1) organized crime in the United States is a highly sophisticated, diversified, and widespread activity that annually drains billions of dollars from America’s economy by unlawful conduct and the illegal use of force, fraud, and corruption; (2) organized crime derives a major portion of its power through money obtained from such illegal endeavors as syndicated gambling, loan sharking, the theft and fencing of property, the importation and distribution of narcotics and other dangerous drugs, and other forms of social exploitation; (3) this money and power are increasingly used to infiltrate and corrupt legitimate business and labor unions and to subvert and corrupt our democratic processes; (4) organized crime activities in the United States weaken the stability of the Nation’s economic system, harm innocent investors and competing organizations, interfere with free competition, seriously burden interstate and foreign commerce, threaten the domestic security, and undermine the general welfare of the Nation and its citizens; and (5) organized crime continues to grow because of defects in the evidence-gathering process of the law inhibiting the development of the legally admissible evidence necessary to bring criminal and other sanctions or remedies to bear on the unlawful activities of those engaged in organized crime and because the sanctions and remedies available to the Government are unnecessarily limited in scope and impact. It is the purpose of this Act to seek the
eradication of organized crime in the United States by strenthening the legal tools in the evidence-gathering process, by establishing new penal prohibitions, and by providing enhanced sanctions and new remedies to deal with the unlawful activities of those engaged in organized crime.
Pub.L. No. 91-452, 84 Stat. 922, title IX § 1 (1970). True to its word, Congress formulated a broad statute, giving law enforcement officials new tools with which to continue the battle. RICO created an entirely new category of offenses. The statute makes collective, ongoing activity, of the sort commonly engaged in by “organized crime,” an offense separate from the underlying violation. For example, it is illegal to participate in the affairs of an “enterprise” through a “pattern” of “racketeering activity.”
See
18 U.S.C. § 1962 (c). “Racketeering activity” is the actual criminal offense, for which the violator may be separately punished. Its definition includes a variety of state law offenses punishable by imprisonment for more than one year, as well as a long list of federal statutes.
See
18 U.S.C. § 1961 (1).
53
A “pat
*1424
tern of racketeering activity” is defined as the commission of at least two acts of racketeering within ten years. 18 U.S.C. § 1961 (5). The statutory definition of “enterprise” includes any individual, group or entity. 18 U.S.C. § 1961 (4).
54
However, the statute does not simply prohibit engaging in a “pattern of racketeering activity.” Rather, it prohibits an individual from using income derived from a pattern of racketeering to acquire an interest in, or establish the operation of, an enterprise. 18 U.S.C. § 1962 (a). It proscribes acquiring or maintaining an interest in, or control of, an enterprise through a pattern of racketeering. 18 U.S.C. § 1962 (b). It also prohibits an individual employed or associated with an enterprise from conducting or participating in its affairs through a pattern of racketeering. 18 U.S.C. § 1962 (c). Finally, it is unlawful to conspire to do any of the above. 18 U.S.C. § 1962 (d).
In addition to criminal sanctions, RICO provides a civil remedy for “[a]ny person injured in his business or property by reason of a violation of section 1962 ____” 18 U.S.C. § 1964 (c). The statute provides for treble damages and attorney’s fees.
Id.
Largely ignored for nearly a decade, this civil remedy provision has now been “found.” Its recent leap from obscurity to notoriety has generated a tremendous volume of litigation. Although the statute is facially clear and unambiguous, its sheer breadth seems to have created problems in the civil context. Courts are reluctant to turn every multiple statutory violation into an action for treble damages and loath to label each multiple violator a “racketeer.” This is especially true in the securities fraud area, where federal statutory remedies already exist.
See e.g., Divco Const. & Realty Corp., Inc. v. Merrill Lynch, Pierce, Fenner & Smith, Inc.,
575 F.Supp. 712, 714-15 (S.D.Fla.1983);
Hokama v. E. F. Hutton & Co., Inc.,
566 F.Supp. 636, 643-44 (C.D.Cal.1983);
Noland v. Gurley,
566 F.Supp. 210, 218 (D.Col.1983);
Harper v. New Japan Securities Intern., Inc.,
545 F. Supp. 1002, 1007-08 (C.D.Cal.1982).
55
Therefore, despite the Congressional admonition that the statute be “liberally construed to effectuate its remedial purposes,” Pub.L. No. 91-452, 84 Stat. 922, title IX § 904(a) (1970), some courts have endeavored to narrow the concededly expansive scope of the statute by judicial fiat.
2.
Securities Related Issues
Defendants argue that the legal deficiency of the underlying securities claims prevents the complaints from alleging the required “pattern” of “racketeering activity.” This challenge is analogous to the one made with respect to vicarious liability — if there is no valid claim for a primary violation, derivative liability cannot
*1425
attach. In the RICO context, defendants argue that if the allegations are insufficient to state a section 10(b) claim, there could be no “fraud in the sale of securities” sufficient to qualify as a predicate act under section 1961(1)(D). Defendants rely upon their earlier assertion that the misrepresentations and omissions were not made “in connection with” the purchase or sale of securities. Since I have decided otherwise, this argument must be rejected. The complaints allege various instances of fraud “in connection with” the purchase or sale of securities, sufficient to state a section 10(b) claim and establish a “pattern” of “racketeering activity.”
56
Reaching back to the securities issues once again, defendants reassert that there is no “loss causation” between the alleged fraud and injury. Defendants reason that without loss causation, plaintiffs injuries cannot be “by reason of” a violation of section 1962. However, defendants do not explain or elaborate upon this theory. They may be intimating that “loss causation” in a securities sense is also a requirement under section 1964(c). However, I shall not decide this issue, especially considering defendant’s non-existent analysis.
But see Seawell v. Miller Brewing Co.,
576 F.Supp. 424, 430 (M.D.N.Car.1983) (independent, intervening act will break chain of causation required by section 1964(e)). If defendants are making the derivative liability argument discussed above, they may have a valid challenge. Causation is an element of a section 10(b) cause of action. If there is no loss causation, plaintiffs will not have stated a securities fraud claim. Without a valid securities fraud cause of action, that claim cannot serve as a predicate offense under RICO.
See Moss v. Morgan Stanley, Inc.,
719 F.2d 5, 18-19 (2d Cir.1983).
See also Tenaglia v. Cohen,
No. 83-1814 slip op. at 15-16 (E.D.Pa. March 8, 1984) (failure to state securities claim will defeat RICO claim based upon “fraud in the sale of securities”);
Somerville v. Major Exploration, Inc.,
576 F.Supp. 902, 913-14 (S.D.N.Y.1983) (same);
Mauriber v. Shearson/American Express, Inc.,
546 F.Supp. 391, 397 (S.D.N.Y.1982) (same). I have concluded that defendant’s failure to disclose
Brown
did not cause plaintiff’s injuries in the loss causation sense. Thus, with respect to that claim only, recovery would be barred under section 10(b) and under RICO.
57
*1426
The RICO counts in Gaugler, Singer, Rastelli and Shulik embrace all the alleged acts of fraud. As I have concluded earlier, there are allegations of omissions and misrepresentations other than
Brown,
which state valid claims under section 10(b). Therefore, the RICO counts can stand without
Brown.
As noted earlier, the purported class representatives in Taraborelli rely exclusively upon the failure to disclose
Brown.
Since that does not satisfy the dictates of section 10(b), there is a failure to state a claim under RICO as well.
I am compelled to raise,
sua sponte,
a flaw in the Gaugler RICO count. Plaintiff alleges that the “enterprises” in which Catanella gained an interest were plaintiffs securities accounts. Gaugler Amended Complaint at ¶71. While it is true that the complaint does not state or reasonably infer that Catanella gained an interest in plaintiffs portfolio, this issue is immaterial. No conceivable reading of the statutory definition would support a conclusion that securities accounts qualify as “enterprises.”
See
18 U.S.C. § 1961 (4). Thus, the RICO count shall be dismissed without prejudice for failure to allege the existence of a legally appropriate “enterprise” under the statute. Plaintiff shall have twenty days within which to amend the RICO count. Earlier, I declined to dismiss Count Eleven on technical pleading grounds, reasoning that the prolix allegations with respect to
Brown
might have relevance to the RICO claim. Given my rulings, the only possible relevance these allegations could have would be to show a “pattern” of prohibited activity. The remaining multiple allegations of fraud cast doubt upon the necessity of
Brown
for this purpose. Even assuming its probity on the issue of “pattern” over one hundred paragraphs detailing the facts and holdings of
Brown ad nauseaum
seems unwarranted. This is especially true since the pertinent allegations are summarized elsewhere in the complaint.
See
Amended Complaint at HU 25A-251. Therefore, should plaintiff choose to amend the RICO claim, he would be well advised to ponder the evils of redundancy and the virtues of brevity.
3.
Organized Crime
Expressing concern over the broad sweep of RICO, defendants assert that it was “the clear intention of Congress ... to eradicate
organized crime,
not to turn all civil disputes into RICO claims.”
See e.g.,
Defendants’ Reply Memorandum in Support of the Motion to Dismiss in Gaugler at 23. Defendants then proceed to quote the court in
Waterman Steamship Corp. v. Avondale Shipyards, Inc.,
527 F.Supp. 256, 260 (E.D.La.1981), holding that RICO applies only to the activities of “organized crime.” Defendants appear to be suggesting that a link to organized crime is necessary to state a civil RICO claim. In
Kimmel ,
I refused to impose such a requirement,
see Kimmel v. Peterson,
565 F.Supp. at 490-93, and will not deviate from that holding. However, I feel compelled by the ever increasing caselaw, to update that pri- or discussion.
Given defendants’ argument, it is noteworthy that the so-called organized crime requirement has not found acceptance in the criminal RICO context.
See e.g., United States v. Gottesman,
724 F.2d 1517, 1521 (11th Cir.1984);
United States v. Cauble,
706 F.2d 1322, 1330 (5th Cir.1983);
petition for cert. filed,
— U.S. -, 104 S.Ct. 996 , 79 L.Ed.2d 229 (1984);
United States v. Martino,
648 F.2d 367, 380 (5th Cir.1981),
cert. denied,
456 U.S. 949 , 102 S.Ct. 2020 , 72 L.Ed.2d 474 (1982),
aff'd, reh’ng en banc,
681 F.2d 952 (5th Cir.1982);
aff'd sub. nom, Russello v. United States,
— U.S.-, 104 S.Ct. 296 , 78 L.Ed.2d 17 (1983);
United States v. Uni Oil, Inc.,
646
*1427
F.2d 946, 953 (5th Cir.1981);
cert. denied sub. nom., Corbitt v. United States,
455 U.S. 908 , 102 S.Ct. 1254 , 71 L.Ed.2d 446 (1982).
United States v. Thordarson,
646 F.2d 1323 , 1328-29 n. 10 (9th Cir.),
cert. denied,
454 U.S. 1055 , 102 S.Ct. 601 , 70 L.Ed.2d 591 (1981);
United States v. Aleman,
609 F.2d 298, 303 (7th Cir.1979),
cert. denied,
445 U.S. 946 , 100 S.Ct. 1345 , 63 L.Ed.2d 780 (1980);
United States v. Forsythe,
560 F.2d 1127, 1136 (3d Cir.1977);
United States v. Campanale,
518 F.2d 352, 363 (9th Cir.1975),
cert. denied sub nom., Grancich v. United States,
423 U.S. 1050 , 96 S.Ct. 777 , 46 L.Ed.2d 638 (1976);
United States v. Vignola,
464 F.Supp. 1091, 1095-96 (E.D.Pa.)
aff'd mem.
605 F.2d 1199 (3d Cir.1979),
cert. denied,
444 U.S. 1072 , 100 S.Ct. 1015 , 62 L.Ed.2d 753 (1980). In
Forsythe ,
this Circuit remarked that “the legislative intent was to make RICO violations dependent
upon behavior, not status.” Forsythe,
560 F.2d at 1136 (emphasis added). Yet, on the civil side, where the stakes are presumably not as high, some courts have been willing to restrict a civil RICO claim by requiring a link or nexus with organized crime.
See e.g., Gilbert v. Prudential-Bache Securities, Inc.,
No. 83-1513, slip op. at 4 (E.D.Pa. January 10, 1984);
Divco Const. & Realty Corp., Inc. v. Merrill Lynch, Pierce, Fenner & Smith, Inc.,
575 F.Supp. 712, 714-15 (S.D.Fla. 1983);
Hokama v. E.F. Hutton & Co., Inc.,
566 F.Supp. 636, 643 (C.D.Cal.1983);
Wagner, et al. v. Bear, Stearns & Co., et al,
[1982-1983 Transfer Binder] Fed.Sec.L. Rep. (CCH) ¶ 99,032 at 94,913 (N.D.Ill. 1982);
Noonan v. Granville-Smith,
537 F.Supp. 23, 29 (S.D.N.Y.1981);
Waterman Steamship Corp. v. Avondale Shipyards, Inc.,
527 F.Supp. 256, 260 (E.D.La.1981);
Adair v. Hunt International Resources Corp.,
526 F.Supp. 736, 747-48 (N.D.Ill. 1981) ;
Kleiner v. First National Bank of Atlanta,
526 F.Supp. 1019, 1021-22 (N.D. Ga.1981);
Barr v. WUI/TAS, Inc.,
66 F.R.D. 109, 112-13 (S.D.N.Y.1975).
58
However, the continued vitality of
Wagner, Noonan, Adair
and
Barr
is dubious in light of the recent decisions in
Moss v. Morgan Stanley, Inc.,
719 F.2d 5 (2d Cir. 1983) and
Schacht v. Brown,
711 F.2d 1343 (7th Cir.1983),
cert. denied,
— U.S.-, 104 S.Ct. 509 , 78 L.Ed.2d 698 (1983). Indeed, the overwhelming majority of cases have rejected the organized crime limitation.
See e.g., Sutliff Inc. v. Donovan Cos., Inc.,
727 F.2d 648 at 654 (7th Cir. 1984) ;
Moss v. Morgan Stanley, Inc.,
719 F.2d 5, 21 (2d Cir.1983);
Bunker Ramo Corp. v. United Business Forms, Inc.,
713 F.2d 1272 , 1287-88 n. 6 (7th Cir.1983);
Schacht v. Brown,
711 F.2d 1343 , 1353 (7th Cir.1983),
cert. denied,
— U.S.-, 104 S.Ct. 509 , 78 L.Ed.2d 698 (1983);
Cenco, Inc. v. Seidman & Seidman,
686 F.2d 449, 457 (7th Cir.),
cert. denied,
459 U.S. 880 , 103 S.Ct. 177 , 74 L.Ed.2d 145 (1982);
Bennett v. Berg,
685 F.2d 1053, 1063 (8th Cir. 1982) ,
aff'd en banc,
710 F.2d 1361, 1364 (8th Cir.1983),
cert. denied sub nom., Prudential Ins. Co. v. Bennett,
— U.S.-, 104 S.Ct. 527 , 78 L.Ed.2d 710 (1983);
Jensen v. E.F. Hutton & Co., Inc.,
[Current] Fed.Sec.L.Rep. (CCH) 1199,674 at 97,713 (C.D.Cal.1984);
Willamette Savings & Loan v. Blake & Neal Finance Co.,
577 F.Supp. 1415, 1425-26 (D.Ore.1984);
Fur-man v. Cirrito,
578 F.Supp. 1535 at 1538-1539 (S.D.N.Y.1984);
B.F. Hirsch, Inc. v. Enright Refining Co., 511
F.Supp

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Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/1597541. Public record. Not legal advice.