value had decreased from $ 949,267.50 (as of May 31) to $ 514,187.50 and was still vulnerable to even small movements in the market.
Hutton instructed Serageldin on October 2, 1968, to liquidate the remaining open positions in the Foundation account. He initially resisted that instruction but later began liquidation, targeting reduction of the account by 50 per cent. Without prior notification to Prince Khalid, liquidation of his personal account began on October 3, 1986. Dr. Hafez learned of these efforts only after the fact -- during a telephone conversation with Serageldin the evening of that day. Dr. Hafez asked for an explanation and Serageldin stated he had been instructed to liquidate the personal account along with the Foundation's accounts.
Beydoun wrote Dr. Hafez on October 9, 1986, to propose several alternatives allegedly designed to recover the losses incurred by the Foundation in the accounts traded by Serageldin. Upon receipt of that letter Prince Alwaleed and Dr. Hafez met with Beydoun, Serageldin and other representatives of Hutton-London. At that meeting Dr. Hafez first learned of Beydoun's disagreement with and disapproval of Serageldin's handling of both Prince Khalid's and the Foundation's accounts. Serageldin contended that the large losses sustained by Prince Khalid were the fault of Hutton management, who had required liquidation of the account's various positions at what Serageldin considered an inopportune time. Beydoun instead claimed that Serageldin's overly aggressive trading strategy -- about which Beydoun himself had warned on several occasions -- caused the losses.
Between May and October 1986, Serageldin executed about 63 trades for Prince Khalid's account, 18 of which were "day trades" (positions established and liquidated the same day) and 27 of which were held only overnight (positions established on one day and liquidated the next). The commission varied on how long the account held a particular position; the overnight trades, therefore, afforded defendants a higher commission than day trades. In total, defendants received about $ 189,000 in commissions for trades during the period July through October 1986, and a total of $ 603,900 for the total time the account was open.
During the period Serageldin traded Prince Khalid's account, Serageldin would occasionally contact Dr. Hafez and discuss the purported trading strategy for the Foundation accounts. Defendants knew that Dr. Hafez devoted no time to studying the futures markets and only concerned himself with the trading of Prince Khalid's accounts during the conversations with Serageldin. Defendants also knew that Dr. Hafez understood that Prince Khalid's account was supposed to be traded in the same manner as the Foundation account. Plaintiff contends that explains why Dr. Hafez did not inquire into the trading strategy on behalf of his account. Serageldin allegedly lulled Prince Khalid into a false sense of security by continuously reassuring Dr. Hafez that the accounts Serageldin traded were making money.
The total amount of losses realized between July 8 and October 24, 1986 -- when trading in Prince Khalid's account ceased -- was about $ 1,437,012. Losses from May 31, 1986 -- when the account's value reached its peak -- were $ 2,027,527. Out-of-pocket losses for the time the account remained open were $ 1,096,155.80.
As previously mentioned, the Foundation's losses are the subject of litigation before Judge Leinenweber, Khalid Bin Alwaleed Foundation v. E.F. Hutton & Company, Ltd., et al., 709 F. Supp. 815. That complaint was filed June 10, 1988 (approximately one month earlier than the complaint at bar), and one significant opinion has been issued therein which warrants invocation. On March 13, 1989, Judge Leinenweber granted defendants' motion to dismiss for reasons nearly identical to those at issue here. Khalid Bin Alwaleed Foundation v. E.F. Hutton & Company, Ltd., et al., 709 F. Supp. 815 (N.D. Ill. 1989). In relevant part, that opinion held that (1) the Foundation's complaint failed to meet Rule 9(b)'s particularity requirements respecting plaintiff's claim for churning, and (2) violations of those rules promulgated by the Commodity Futures Trading Commission ("CFTC") do not create private rights of action. Having so dismissed plaintiff's federal claims, the court moved pursuant to Blau Plumbing, Inc. v. S.O.S. Fix-It, Inc., 781 F.2d 604, 611 (7th Cir. 1986), and declined to exercise pendent jurisdiction over the remaining state claims. The Foundation has subsequently amended its complaint to cure the Rule 9(b) difficulties and the litigation continues.
Plaintiff submits twelve claims for relief in his complaint: violations of sections 4b and 4o of the Commodity Exchange Act ("CEA"), violations of the Commodity Futures Trading Commission ("CFTC") Rules 166.3 and 1.55, fraudulent concealment and misrepresentation, constructive fraud, negligence, negligent misrepresentation, breach of contract, rescission and civil conspiracy. After grouping related issues, we discuss these claims below.
I. Private Remedies for CFTC Rules
Defendants allege there is no private cause of action for violations of rules promulgated by the CFTC and that therefore claims three and four should be dismissed. Because we adopt the portion of Judge Leinenweber's Foundation opinions that pertain to this issue, we effectively agree.
Given the particular circumstances of this case, there is no need for two district court judges sitting five floors apart to render separate opinions on this issue. We first note the complaints in these two cases closely track each other: the same defendants, one plaintiff's decision to invest influenced by the other's earlier success, claims for relief being identical, et cetera. The parties in each dispute have also enlisted the services of the same lawyers.
A second opinion on the private remedy issue from another district judge in the same circuit, applying the same facts,
would therefore not likely serve any purpose. We have never before evaluated the private cause-of-action question with respect to CFTC rules and, therefore, we bring only those same arguments counsel have marshalled before Judge Leinenweber to the table. Further, a separate decision by us would have little practical effect. In the event this court differed with Judge Leinenweber and found a private remedy, our disagreement would be consolidated and appealed together. If we agreed, nothing more would come of it.
Therefore, the appropriate course is to adopt the portion of Judge Leinenweber's opinion dismissing claims for relief stemming from violations of CFTC Rules 1.55 and 166.3. See 709 F. Supp. at 817-821. There, as here, those allegations were found in claims three and four. Accordingly, we dismiss them here as well.
II. Pleading Fraud with Particularity
We do not, however, cede resolution of the Rule 9(b) questions to Judge Leinenweber. We have visited those issues quite frequently and have on occasion evaluated dismissal motions respecting churning allegations similar to those at bar. Given also that dismissals under Rule 9(b) can be easily cured,
we plunge ahead with our own inquiry.
Churning has been defined as excessive trading in an account over which the broker has control for the primary purpose of generating commissions. See Yopp v. Siegel Trading Co., Inc., 770 F.2d 1461, 1465 (9th Cir. 1985). It describes a particular species of unauthorized trading which provides a separate and additional claim when high commission charges stem from an amount of trading that exceeds what is appropriate for the client's investment goals. Such trading, of course, breaches a broker's fiduciary duty. Id.
The requisite allegations to pleading churning in a commodities account mirror those for securities transactions. While courts do not apply a single test or formula, we have embraced three requirements. A plaintiff must show that
(1) broker control of the account, and (2) excessive trading of the account which was (3) intentional or willful, i.e., for the purpose of generating unnecessary commission or at least with reckless disregard for the client's interest. . . . Usually the intent or recklessness will be implicit in the nature of the conduct.
Evanston Bank v. Conticommodity Services, Inc., 623 F. Supp. 1014, 1024 (N.D. Ill. 1985), (citing Yopp, 770 F.2d at 1466, applying Mihara v. Dean Witter & Co., 619 F.2d 814 (9th Cir. 1980); Costello v. Oppenheimer & Co., 711 F.2d 1361, 1368 (7th Cir. 1983); Armstrong v. McAlpin, 699 F.2d 79, 91 (2d Cir. 1983)).
Defendants contend that the complaint fails to allege (1) facts indicating when trades were made and whether those trades involved commodities, and (2) facts sufficient to ascertain the applicable turnover ratio or percentage of the account value paid in commission. Before we evaluate these particular alleged inadequacies, we note generally that defendants are in the best position to submit answers to the very questions they offer and will have a concrete opportunity to reallege their claims after discovery. Judge Kaufman, of the Second Circuit, framed the position as follows:
Appellees have at their disposal the means to trace the history of Saxe's account. Moreover, the specificity of the allegedly excessive trading, in contravention to Saxe's investment objectives, can be developed at the summary judgment stage or at trial. Accordingly, we believe the parties should be permitted to proceed to discovery. See Bowman v. Hartig, 334 F. Supp. 1323, 1326-27 (S.D.N.Y. 1971). Once discovery is complete, however, there may remain no claim for relief and summary judgment may be pursued, if appropriate. See A. T. Brod v. Perlow, 375 F.2d 393, 398 (2d Cir. 1967), 375 F.2d at 398. Accordingly, we reverse the dismissal of Saxe's churning claim.