The opinion of the court was delivered by: DUFF
BRIAN BARNETT DUFF, UNITED STATES DISTRICT JUDGE
Plaintiffs Hudson T. Harrison and Hudson T. Harrison, Inc. have sued Dean Witter Reynolds, Inc. ("Dean Witter") and two of its broker-dealers, John M. Carpenter and John G. Kenning, under § 10(b) of the Securities Exchange Act of 1934 ("the Securities Exchange Act"), 15 U.S.C. § 78j(b) ("§ 10(b)"), § 20(a) of the Securities Exchange Act, 15 U.S.C. § 78t(a) (§ 20(a)"), the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. §§ 1961 et seq., and a number of state laws. Dean Witter has moved for summary judgment on all claims.
This case contains two stories. The first story is about Dean Witter, and how it allowed Kenning and Carpenter to use its name and its office as part of a massive scheme to defraud investors. The second story is about Harrison, about how he threw millions of dollars at Kenning and Carpenter in the hopes of securing spectacular returns with no risk, and found himself millions of dollars poorer for his greed. Viewing all facts most favorably for Harrison, here's what happened.
Dean Witter's story begins back in mid-1983, when Kenning and Carpenter left the employ of a Florida branch of Prudential-Bache Securities, Inc. under questionable circumstances involving a failed complex securities transaction. Within weeks, a Dean Witter Florida branch office hired the two, after conducting an investigation into the affair and after the New York Stock Exchange approved Kenning's application for transfer of his broker-dealer registration.
Richard Frost, the local Dean Witter branch manager, made Kenning a vice president and account executive. Carpenter, who was not registered, became Kenning's assistant and established an account in his own name at Dean Witter. Kenning controlled the account, and had Carpenter establish it primarily because Kenning was facing bankruptcy. Frost's signature was required on any order ticket for the account.
Carpenter and Kenning soon began accumulating huge sums in Carpenter's account by soliciting clients to become involved in municipal bond deals. They told their clients that the funds would be pooled and used to purchase these low risk bonds at substantially reduced prices and commissions -- discounts available, they said, because they were Dean Witter employees and because of the large sums of money involved. As it turns out, however, Carpenter and Kenning did not invest in municipal bonds at all, but instead in high-risk put options.
Not only were Carpenter and Kenning lying about what they were doing, but they were blatantly violating Dean Witter rules prohibiting employees from commingling their own funds with client funds and from sharing an interest in an account with anyone other than a close relative. By August, 1984, Carpenter and Kenning had displayed an uncanny ability for losing money, having amassed nearly $ 600,000 in losses since starting with Dean Witter. In August, Dean Witter's regional manager, Haskell Adler, met with Kenning's former Prudential-Bache supervisor, who informed Adler that Kenning could not be trusted. Adler did nothing with the information.
In addition, on a number of occasions Alfred Rauschman, the head of Dean Witter's compliance department, contacted Frost to inquire about the heavy volume of trading taking place in Carpenter's account. Dean Witter's internal rules require supervisors to ensure that an employee's investments are commensurate with his resources. Frost questioned Carpenter and Kenning about their activities, but when Carpenter explained that the money was his own, Frost looked no further, demanding only that Carpenter have cash on hand for every purchase he made. Although Dean Witter rules prohibit employees from receiving checks in their own names, and require branch managers to screen all incoming and outgoing correspondences, Carpenter and Kenning avoided discovery of their scheme by having their clients send them money either at home or to their personal bank accounts.
Harrison's story begins in February, 1985, with Kenning and Carpenter still actively engaged in their fraudulent scheme. At this time, Harrison, an Illinois millionaire with considerable investment experience, traveled to Florida with his friend, John Cahoon. There he met Carpenter for the first time and stayed at Carpenter's home. During the trip, Cahoon and Carpenter mentioned the bond deals which Carpenter and Kenning were offering to their larger clients. Before leaving Florida, Harrison expressed an interest in the deals.
Upon returning to Illinois, Harrison received a call from Kenning or Carpenter asking him if he wanted to participate in the bond deals. Over the next few weeks, the two Dean Witter employees spoke with Harrison on a number of occasions and explained that the bond deals would require Harrison to provide Kenning and Carpenter with funds which they would then place in their own accounts at Dean Witter. They would use these funds to purchase municipal bonds, nearing maturity, at a substantial discount. Harrison would earn some interest in the period before maturity, and then a large gain when the bonds were redeemed at par value. The discounts, the two told Harrison, were not available in transactions out of a customer's account.
Harrison made his first investment of $ 200,000 with Kenning and Carpenter on February 28, 1985, and over the next 16 months, 15 additional investments totaling approximately $ 2.8 million. Harrison also made two investments, totaling $ 1.1 million, out of HCI funds. At Carpenter's request, Harrison made two of these investments by wire transfer to Carpenter's personal checking account, and the rest by mailing checks to Carpenter at his home address.
In return for the investments, Carpenter and Kenning provided Harrison with what were fashioned to be personal promissory notes, but which Harrison believed were receipts for his bond purchases. The due dates of the notes generally coincided with the due dates of the bonds. The notes provided for Harrison to receive at the due date an interest rate commensurate with the return Harrison expected to receive on the bond deals. On an annualized basis, these notes contained interest rates ranging from approximately 18% to 60%. Dean Witter's name did not appear on any of the notes, and Harrison never received any confirmation or statement from Dean Witter regarding his investments with Kenning and Carpenter.
Through July, 1986 Carpenter repaid out of his personal checking account and in cash approximately $ 800,000 to Harrison and HCI. Harrison believed these payments represented profit generated from his interest in the municipal bonds, though Carpenter provided him with tax forms stating that Harrison and HCI had received interest income from Carpenter. Harrison also declared $ 46,296.51 on his 1985 tax return as interest income on the monies he had given Carpenter for bond investments during 1985.
In July, 1986, Carpenter and Kenning flew to Illinois to inform Harrison that they had lost all of Harrison's money. When Harrison asked how they could have suffered such losses in municipal bonds, Carpenter informed him that they had been investing his money in far riskier instruments. Carpenter offered to establish a plan for repaying Harrison, but when he failed to produce such a plan in writing, Harrison sent letters to Carpenter and Kenning demanding immediate payment of all money due himself and HCI. Harrison did not notify Dean Witter of his losses, nor demand payment from Dean Witter, until he filed his lawsuit.
Of the 11 counts remaining in Harrison's 12-count first amended complaint,
nine -- one § 10(b) claim, one RICO claim, and seven state law claims
-- seek to impose liability against Dean Witter vicariously for the acts of Kenning and Carpenter. One claim, a negligence claim, alleges that Dean Witter itself -- that is, Dean Witter's management level personnel, see D&S Auto Parts, Inc. v. Schwartz, 838 F.2d 964, 967-68 n.5 (7th Cir. 1988) -- violated Harrison's rights. And one claim, a § 20(a) claim, involves a combination of the two. The court will address these theories of ...