omit to disclose material information in connection with the purchase or sale of securities. Drexel contends that plaintiffs fail to allege that it misrepresented or omitted to disclose any material facts. Instead, according to Drexel, plaintiffs merely claim that Drexel breached an alleged fiduciary duty to the Funds which enabled Poder to engage in the unauthorized trades. Drexel argues that such a breach of fiduciary duty does not violate Section 10(b) or Rule 10b-5.
The Village contends that its theory of liability is based upon Rule 10b-5(a) and (c), not 10b-5(b) because there was a "deceptive course of business and not a misrepresentation, omission or a naked breach of a fiduciary duty. . . ." Arlington Heights Mem. at 3 (emphasis in original). The Funds, however, allege violations of Rule 10b-5(a), (b), and (c). See Police Fund Complaint, para. 9; Fire Fund Complaint, para. 7. Plaintiffs also argue that Drexel "had an obligation to verify that Poder was authorized to direct the trades that Drexel . . . executed. Its failure to do so is the omission which gives rise to a violation of Rule 10b-5." Fire Fund Mem. at 8.
Rule 10b-5 has three subsections. In addition to prohibiting material misrepresentations or omissions in subsection (b), subsections (a) and (c) clearly prohibit the use of "any device, scheme, or artifice to defraud" and the commission of "any act, practice, or course of business which operates or would operate as a fraud or deceit." 17 C.F.R. 240.10b-5 (a) and (c). Subsections (a) and (c) do not require a misrepresentation or omission. See Affiliated Ute Citizens v. United States, 406 U.S. 128, 153, 31 L. Ed. 2d 741, 92 S. Ct. 1456 (1971) (although subsection (b) of Rule 10b-5 requires an untrue statement or omission of material fact, subsections (a) and (c) "are not so restricted"). The complaints allege that Drexel's conduct operated as a fraud in connection with the purchase or sale of a security. Accordingly, these allegations are sufficient to withstand a motion to dismiss. Arlington Heights Police Pension Fund v. Poder, 700 F. Supp. 405, 406 (N.D.Ill. 1988) (Bua, J.).
With respect to Rule 10b-5(b), the Seventh Circuit has recently stated that "an omission or misstatement is material if a substantial likelihood exists that a reasonable investor would find the omitted or misstated fact significant in deciding whether to buy or sell a security." Rowe v. Maremont Corp., 850 F.2d 1226, 1233 (7th Cir. 1988). The Funds allege that Drexel failed to inform them that Poder was making unauthorized transactions. As stated in a recent case involving similar allegations: "The relevant omission alleged is the failure to inform the investor that defendant was making purchases and sales. No omission could be more material than that." Hometown Sav. & Loan Ass'n v. Moseley Securities Corp., 703 F. Supp. 723, 724 (N.D.Ill. 1988) (Norgle, J.) (emphasis added). See also Board of Trustees v. Poder, Nos. 88 C 3851, 88 C 3895, slip op. at 3 (N.D.Ill. Jan. 24, 1989) (Norgle, J.). This Court agrees with Judge Norgle's analysis. Drexel's alleged failure to inform the Funds of Poder's transactions was clearly a material omission. Accordingly, plaintiffs' allegations meet the requirements of Rule 10b-5(b).
2. " In Connection With "
"Section 10(b) and Rule 10b-5 are directed at fraud 'in connection with the purchase or sale' of securities." Congregation of the Passion, Holy Cross v. Kidder Peabody, 800 F.2d 177, 181 (7th Cir. 1986) (citations omitted). Drexel contends that the conduct alleged by the plaintiffs does not satisfy the "in connection with" requirement because "any deception alleged by plaintiffs related solely to the issue of Poder's authority to engage in the transactions at issue and was not in connection with the purchase or sale of any security." Drexel Reply Mem. at 6.
To support this argument Drexel relies on three cases that are clearly distinguishable from the facts in the present case. In each of these cases the plaintiffs knowingly surrendered their rights to make decisions concerning the purchase or sales of securities. In the first case, O'Brien v. Continental Illinois Nat. Bank and Trust Co., 593 F.2d 54 (7th Cir. 1979), plaintiffs (trustees of nine union or employee pension trust funds) entered into an agreement with the defendant bank "under which the funds of the pension trust were turned over to the bank for investment." Id. at 57. The bank "was given the responsibility of making such investments as in its sole discretion it saw fit, subject to a fiduciary duty of due care." Id. The plaintiffs had "no right to receive notice of, or to be consulted about, proposed investments and no right to veto investment decisions." Id.5
In the present case, plaintiffs allege that they never delegated any authority to Poder, nor were they aware of the accounts Poder opened with Drexel. Thus, they were completely denied information that would or might have been useful in deciding to buy or sell the securities that were traded in their accounts.
The second case relied upon by Drexel is Congregation of the Passion, Holy Cross v. Kidder Peabody, 800 F.2d 177 (7th Cir. 1986). In that case plaintiff hired an investment advisor to manage its retirement funds. That advisor was given authority to execute investment transactions on behalf of the funds. The defendants executed the transactions requested by the advisor. Id. at 178-79. As in O'Brien, the court found that there was no violation of Section 10(b) or Rule 10b-5 where the plaintiff transferred the full authority to make investment decisions to an investment advisor. Thus, the plaintiff did not have to approve each transaction. Id. at 181. As discussed above, the complaints in the present case do not allege that plaintiffs transferred any authority to Poder to make investment decisions for the Funds.
Finally, Drexel relies on Capalbo v. Paine Webber, Inc., 672 F. Supp. 1048 (N.D.Ill. 1987) in which there had been a previous delegation of authority to a securities broker to make investment decisions. Relying on O'Brien and Congregation of the Passion, Judge Norgle dismissed two counts after concluding that there was no violation of Rule 10b-5 because the alleged misrepresentations and omissions did not relate to the plaintiff's decision to purchase or sell securities. Instead, the alleged fraudulent conduct related to the plaintiff's decision to retain an investment account. Id. at 1052. Unlike Capalbo, plaintiffs here made no such decision to retain an investment account.
The allegations in the present case are that: (1) the Funds had the exclusive authority to make investment decisions; (2) securities were purchased and sold without the Funds' consent; (3) Drexel knew or acted with reckless disregard of the fact that Poder had no authority to invest the Funds' assets through the Drexel account; (4) the trades Poder directed were unsuitable and speculative; (5) Drexel intentionally failed to inform the Funds of the trades; and (6) Drexel's execution of trades resulted in the losses incurred by the Funds. Accepting these allegations as true, the alleged fraud was in connection with the purchase or sale of securities. Therefore, the complaints satisfy the "in connection with" requirement of Section 10(b) and Rule 10b-5.
3. Loss Causation
Drexel contends that plaintiffs fail to adequately allege "loss causation." In securities fraud cases, plaintiffs must prove both "loss causation" and "transaction causation." "'Loss causation' means that the investor would not have suffered a loss if the facts were what he believed them to be; 'transaction causation' means that the investor would not have engaged in the transaction had the other party made truthful statements at the time required." LHLC Corp. v. Cluett, Peabody & Co., Inc., 842 F.2d 928, 931 (7th Cir. 1988). Drexel argues that because plaintiffs failed to allege that Drexel made any misrepresentations of fact, material or otherwise, regarding the nature of the securities purchased by Poder, plaintiffs' federal securities claims must be dismissed for failure to allege "loss causation."
In rejecting Drexel's argument, the Court adopts the well-reasoned opinion of Judge Duff in a recent case involving similar allegations of unauthorized trading:
In most § 10(b) and Rule 10b-5 cases, the plaintiff has agreed to purchase a security based on the defendants' misrepresentations or omissions about it. In these cases, the loss causation requirement means the plaintiff must prove that he would not have suffered the loss -- i.e., the price of the security would not have fallen -- had the facts been as he believed them to be. Here, however, plaintiff alleges that, had the facts been as he believed them to be, he would not have made the purchases at all. In such a case, transaction causation and loss causation merge: Since the plaintiff believed he was making no investment at all, any loss on the investment is directly related to the subject of defendant's fraud.