The opinion of the court was delivered by: Getzendanner, District Judge.
MEMORANDUM OPINION AND ORDER
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
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 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
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
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 ...