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December 29, 1981


The opinion of the court was delivered by: Getzendanner, District Judge.


This matter had its genesis in a precipitous drop in the price of several securities in the spring of 1977. In sixteen separate cases, which have been consolidated for discovery purposes, charges of securities fraud and a host of other claims have been brought against Loeb Rhoades & Co., Loeb Rhoades & Co., Inc. [hereinafter referred to, along with the subsidiary First Wall Street Settlement Corp., as "Loeb Rhoades"], and other defendants. In fifteen of those cases,*fn1 Loeb Rhoades has filed what it titles a "First Amended Counterclaim, Cross-Claim and Third Party Complaint." The parties against whom these claims run have moved to dismiss Loeb Rhoades' pleading.*fn2

In the fifteen cases, Loeb Rhoades has been charged with violations of federal and Illinois securities laws, of the Investment Advisers Act, and of the Rules of the National Association of Securities Dealers, common law fraud, breach of contract, breach of fiduciary duty, and negligence. These cases range from single plaintiff, single defendant complaints to multiple plaintiff, multiple defendant complaints; several complaints include class allegations.*fn3 A number of plaintiffs are named as defendants by other plaintiffs in separate cases. Besides Loeb Rhoades, one other defendant has filed a cross-claim/third party complaint.

The allegations in the fifteen complaints encompass a variety of misconduct. Although these allegations vary from one case to another, in general the complaints allege that Loeb Rhoades, through its employee Jack Bernhardt, induced purchases of stock in Olympia Brewing Co. by misrepresenting that Olympia was about to be acquired by another corporation and that a tender offer was imminent. A number of plaintiffs further allege that Loeb Rhoades failed to adequately supervise Bernhardt and that after his discharge it concealed the reasons for his leaving. There are also allegations that Loeb Rhoades stimulated and maintained artificially high prices in Olympia stock, as well as in the stock of three other companies, Fay's Drugs, Inc., Stange Corp., and Lawry's Foods. Other plaintiffs allege that Loeb Rhoades manipulated the market to depress the price of Olympia stock through concerted short selling. Finally, several plaintiffs accuse Loeb Rhoades of unauthorized trading in their accounts and with failures to execute their sell orders. This brief overview of the cases gives some sense of the scope of the underlying litigation.

Loeb Rhoades's Counterclaim*fn4 contains seven counts. In Count I, Loeb Rhoades alleges that counterdefendants*fn5 conspired to, aided or abetted another to, or actually misused the trading and credit facilities of Loeb Rhoades in violation of the federal and Illinois securities laws. Count II alleges that the same conduct constitutes common law fraud. Count III alleges that if any plaintiff recovers against Loeb Rhoades, Loeb Rhoades is entitled to indemnity from all counterdefendants. Alternatively, in Count IV, Loeb Rhoades alleges that if any plaintiff recovers against it, each counterdefendant other than that plaintiff is jointly and severally liable under the principles of contribution.

Count V is a pendent contract claim and it alleges that each counterdefendant who maintained a brokerage account with Loeb Rhoades signed a Customer's Agreement by which that person agreed to reimburse Loeb Rhoades for any loss or expense incurred in connection with that person's account. In Count VI, Loeb Rhoades alleges that counterdefendants' conduct, as set out in Count I, constitutes a pattern of racketeering and that it has suffered injury as a result of such activity. In Count VII, Loeb Rhoades alleges that it is entitled to recoupment in the event that it is adjudged liable to any plaintiff.

As explained in detail below, the court grants plaintiffs' motions to dismiss Counts I, II, VI and VII. The motions are denied as to Counts III, IV and V, although the court limits the scope of these counts and requests Loeb Rhoades to file a second amended counterclaim incorporating those limitations.


Loeb Rhoades first sought leave to amend its answer and file its counterclaim some nine months after the last of the sixteen cases against it had been filed. Plaintiffs/counterdefendants*fn6 strenuously argue that the counterclaim should be dismissed as untimely. The court, however, after considering the scope of this controversy and the number of parties involved, is persuaded that in the long run it is in the interests of the efficient administration of justice to reach the merits of the counterclaim. The court has decided on this course primarily because it is likely that the question of the alleged conspiracy or scheme to defraud will be litigated in these actions as a defense, regardless whether it is allowed as a counterclaim. To avoid even the possibility of a second round of lawsuits, the court is willing to consider Loeb Rhoades's claims in the instant actions.

This decision is "in line with the Federal Rules' overall goal of resolving disputes, insofar as possible, on the merits and in a single proceeding. See Foman v. Davis, 371 U.S. 178, 83 S.Ct. 227, 9 L.Ed.2d 222 (1962)." Spartan Grain & Mill Co. v. Ayers, 517 F.2d 214, 220 (5th Cir. 1975). Accordingly, the court will proceed to the merits of each of Loeb Rhoades's claims.

Securities and Common Law Fraud

In Counts I and II, Loeb Rhoades seeks to recover from counterdefendants on the basis of securities and common law fraud, respectively. Both counts share a common defect and both must be dismissed.

Loeb Rhoades alleges that between 1975 and the present, counterdefendants conspired to, aided others to, or did in fact misuse its trading and credit facilities. This misuse took the form of placing orders with no intention of completing the purchase on the settlement date, misrepresenting the amount of funds on hand to purchase securities, secretly borrowing funds to purchase securities, obtaining loans by pledging securities that could not be pledged, improperly extending credit to other counterdefendants, unlawfully forming a syndicate, and concealing these and other fraudulent acts from Loeb Rhoades.

Loeb Rhoades does not allege that any of these actions resulted in any loss to Loeb Rhoades. But it argues that to conceal this misconduct and "to shift the blame," plaintiffs/counterdefendants filed their suits against Loeb Rhoades and accused it of fraud. With respect to those counterdefendants who did not themselves file suit, Loeb Rhoades contends that they intended or reasonably foresaw that others would file suit against Loeb Rhoades. Loeb Rhoades alleges that it has suffered injury in the expense of defending these suits and in damage to its business reputation as a result of being named a defendant. It argues that these injuries were "caused" by counterdefendants' fraud.

In testing the sufficiency of the counterclaim, this court must, of course, accept as true the allegations in the complaint. Walker Process Equipment, Inc. v. Food Machinery & Chemical Corp., 382 U.S. 172, 174-75, 86 S.Ct. 347, 348-349, 15 L.Ed.2d 247 (1965) (allegations of fraud and of resulting damage must be taken as true). This truism, however does not prevent the court from determining whether, as a matter of law, the damages claimed by Loeb Rhoades are the result of the fraud alleged. The issue here is one of causation. It is the relation of the damages claimed to any misconduct, not the fact or the existence of those damages, that is in question.

As the court views the amended counterclaim, Loeb Rhoades has alleged a fraudulent scheme in connection with the purchase or sale of securities, but no damages to it*fn7 as a result of that fraudulent scheme, and, conversely, it has alleged damages resulting from the filing of the sixteen lawsuits, but has not shown that these constitute fraud in connection with the purchase or sale of securities. The "weak link" in Loeb Rhoades's argument is the allegation that the lawsuits were filed to "cover up" counterdefendants' fraud. Assuming arguendo that this allegation is true, that does not make the "cover up" — the filing of the suits — fraudulent conduct in connection with the purchase or sale of any securities.

Causation as an Element of Recovery

A cause of action under § 10(b) of the 1934 Act, 15 U.S.C. § 78j(b), and Rule 10b-5 must allege fraud in connection with the purchase or sale of securities. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 731, 95 S.Ct. 1917, 1923, 44 L.Ed.2d 539 (1975). Similarly, a cause of action under § 17(a) of the 1933 Act, 15 U.S.C. § 77q(a), proscribes fraud in the offer or sale of any securities.*fn8 The two sections are essentially the same, although the reach of § 10(b) is broader. Jackson v. Oppenheim, 411 F. Supp. 659, 665 (S.D.N Y 1974), aff'd in part, rev'd in part, 533 F.2d 826 (2d Cir. 1976). Because private rights of actions under these sections were judicially created, the statutes do not set out the elements of the cause of action. Courts and commentators, however, have read a causation requirement into any cause of action under the statutes. See, e.g., Garnatz v. Stifel, Nicolaus & Co., 559 F.2d 1357, 1360 (8th Cir. 1977), cert. denied, 435 U.S. 951, 98 S.Ct. 1578, 55 L.Ed.2d 801 (1978) (defendant liable for such damages as naturally and proximately result from the fraud); Globus v. Law Research Service, Inc., 418 F.2d 1276, 1291 (2d Cir. 1969), cert. denied, 397 U.S. 913, 90 S.Ct. 913, 25 L.Ed.2d 93 (1970) (damages must be a proximate result of misleading statements); Franklin Life Instrument Co. v. Commonwealth Edison Co., 451 F. Supp. 602, 607-08 (S.D.Ill. 1978) aff'd, 598 F.2d 1109 (7th Cir.), cert. denied, 444 U.S. 900, 100 S.Ct. 210, 62 L.Ed.2d 136 (1979) (necessary element is a causal relationship between the violation and the injury); Miller v. Schweickart, 413 F. Supp. 1062, 1067 (S.D.N.Y. 1976) ("well-recognized" that fraud must be proximate cause of loss); Comment, "Civil Liability Under Section 10b and Rule 10b-5: A Suggestion for Replacing the Doctrine of Privity," 74 Yale L.J. 658, 661 (1965) ("obvious" that defendant's misconduct must cause plaintiff's injury).

Courts have also recognized that consequential damages are recoverable under the statutes. E.g., Madigan, Inc. v. Goodman, 498 F.2d 233, 238 (7th Cir. 1974). Accord, Arrington v. Merrill Lynch, Pierce, Fenner & Smith, 651 F.2d 615, 621 (9th Cir. 1981); Foster v. Financial Technology, Inc., 517 F.2d 1068, 1071 (9th Cir. 1975); Zeller v. Bogue Electrical Manufacturing Corp., 476 F.2d 795 (2d Cir. 1973), cert. denied, 414 U.S. 908, 94 S.Ct. 217, 38 L.Ed.2d 146 (1973); deHaas v. Empire Petroleum Co., 435 F.2d 1223, 1228-29 (10th Cir. 1970). In order to recover consequential damages, however, a plaintiff must establish the "requisite causal nexus." Madigan, supra. The plaintiff must show "with reasonable certainty that such damages were caused by the defendants' 10b-5 violation." Foster, supra.

In Madigan, the plaintiffs sought to recover various categories of consequential damages, including capital contributions and litigation expenses. Plaintiffs alleged that as a result of defendants' understatement of the available reserves for losses and loss adjustment expenses, they were induced to purchase stock in an insurance company that was in serious financial trouble. Upon discovering the true state of the insurance company's condition, plaintiffs made capital contributions to the company in an unsuccessful effort to prevent its insolvency. The plaintiffs were also forced to expend sums in defending the liquidator's suit against them after the insurance company went into bankruptcy.

In that suit, which was still pending at the time the Seventh Circuit issued its opinion in Madigan, the liquidator alleged that the insurance company was solvent when the plaintiffs purchased it and that they promptly "looted" it, leaving only a "corporate shell." The Madigan plaintiffs, however, managed to sell their stock at the same price for which they had purchased it.

The Seventh Circuit reasoned that, even though plaintiffs had suffered no loss as to the stock itself, they were "entitled to recover out-of-pocket consequential damages suffered as a result of holding [the] stock." 498 F.2d at 238, (emphasis added). The Court therefore held that capital contributions made in an attempt to save the company might be recoverable. The Court went on to state:

  "We also hold that expenses from related litigation
  and damages from inability to plan as a result of
  that litigation are not recoverable. These damages
  are not a direct consequence of defendants' alleged
  fraud. Taking the complaint as true, these damages
  are a result of the liquidator's gross misperception
  of what actually happened. Defendants could not have
  foreseen that a third party would blame their fraud
  on the ...

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