The opinion of the court was delivered by: MORAN
JAMES B. MORAN, UNITED STATES DISTRICT JUDGE
Plaintiff His Royal Highness Prince Khalid Bin Talal Bin Abdul Azaiz Al Seoud ("Prince Khalid") brings this action against defendants E. F. Hutton & Company ("Hutton-New York"), E. F. Hutton & Company (Securities) Limited ("Hutton-London") (collectively "Hutton" defendants), Sharif Serageldin ("Serageldin"), and Sami Beydoun ("Beydoun"), alleging illegal handling of his commodities account. We have before us defendants'
motions to dismiss, strike and for a more definite statement. Dismissal is urged pursuant to Rules 9(b) ("circumstances constituting fraud or mistake shall be stated with particularity") and 12(b)(6) ("failure to state a claim upon which relief can be granted"); the motion to strike certain paragraphs of the complaint pursuant to Rule 12(f) ("redundant, immaterial, impertinent, or scandalous matter"); and the motion for a more definite statement of the contract claim pursuant to Rule 12(e) ("party cannot reasonably be required to frame a responsive pleading") of the Federal Rules of Civil Procedure.
In such circumstances, any inference drawn must be favorable to the plaintiff, United Milk Products Co. v. Michigan Avenue National Bank of Chicago, 401 F.2d 14, 17 (7th Cir. 1968), and the allegations contained in the complaint are to be accepted as true, National Van Lines, Inc. v. United States, 326 F.2d 362, 372 (7th Cir. 1964). For the following reasons, the motion to dismiss, strike and for a more definite statement is granted in part and denied in part.
Viewing the complaint in the light most favorable to plaintiff, the facts underlying this dispute appear as follows:
Prince Khalid is a member of the Royal House of Saudi Arabia and the brother of Prince Alwaleed Abdul Aziz Al Seoud ("Prince Alwaleed"). The latter, Prince Alwaleed, established a foundation, of which he is trustee, whose financial dealings are the subject of parallel litigation before Judge Leinenweber, Khalid Bin Alwaleed Foundation v. E. F. Hutton & Company, Ltd., et al., 709 F. Supp. 815 (N.D.Ill. 1989) ("Foundation" litigation).
Defendants Serageldin (senior portfolio manager at Hutton-London) and Beydoun (first vice-president and manager of Hutton-London) presented a proposal to Prince Alwaleed and his financial advisor, Dr. Zia M. Hafez ("Dr. Hafez"), to invest Foundation funds through Hutton-London. The offer was first made in late 1984 and was presented in its final form in April 1985. In early May 1985, Serageldin reviewed the proposal with Prince Alwaleed and Dr. Hafez, and represented that he and Hutton were experienced in managing discretionary commodity interest trading accounts, possessed the requisite knowledge, skill and judgment to engage successfully in futures trading, and would "conservatively" exercise their discretion.
On March 11, 1986, Serageldin reported in writing to Prince Alwaleed that the Foundation's $ 5 million investment had grown to $ 6.94 million as of February 28, 1986. In early April 1986, Serageldin used these successes to acquire the additional business of plaintiff Prince Khalid. He traveled to Saudi Arabia, met with Prince Khalid and Dr. Hafez (the latter also advised the former), and represented that trading on Prince Khalid's personal account would proceed in the same conservative manner as the Foundation's account: investing only 10 to 30 per cent of the funds in commodities, namely T-bonds, stock indexes such as the S & P 500, currencies such as the Deutsch Mark and Pound Sterling, and precious metals, principally gold and silver. Serageldin highlighted his ability to read "cycles" in the market and emphasized his intention to position the account to take full advantage of them. He also represented how he could minimize losses, citing his having turned the Foundation's losses in December 1985 into profits. Based on his past record, Serageldin stated he expected to achieve a 20 to 30 per cent return per year on the investment. These representations led Prince Khalid to open an account for $ 1.5 million which Serageldin agreed to trade in tandem with the Foundation's accounts and in a like manner. Serageldin subsequently directed all trades in Prince Khalid's account between May and October 1986.
As of May 31, 1986, the account of Prince Khalid was worth $ 2,431,371. Soon thereafter, and without prior disclosure to or authorization from Prince Khalid or Dr. Hafez, Serageldin changed the manner in which he handled the account: he did not trade in diverse commodity interests, held a substantial number of losing open positions for long periods of time and committed more than 30 per cent of the account's funds. For example, Serageldin traded only in T-bonds and S & P 500 index, except for an isolated silver trade in May 1986, and two others in June 1986. That exposed the account to huge losses from even small movements of those markets. He avoided diversifying the account's portfolio by failing to purchase commodity interests which moved differently than the then existing holdings. As the market moved adversely to the commodity interests then held, Serageldin increased the number of those interests, attempting to "average" the costs of positions. This technique represented a desperate effort to recover the existing significant losses to save the defendants' reputations.
Neither Serageldin, nor anyone else at Hutton, advised Dr. Hafez or Prince Khalid that the strategy for trading in the commodity account had changed or that losses of $ 611,115.60 in June 1986 and $ 428,680.25 in July 1986 were sustained. In fact, Dr. Hafez and Prince Khalid did not learn of the June and July losses until September 1986. Even as Beydoun internally questioned Serageldin's strategy, he failed to disclose those reservations to either Dr. Hafez or Prince Khalid because of his desire to generate commissions.
On September 24, 1986, Beydoun contacted Dr. Hafez and advised him that the Foundation's account had sustained unrealized losses of approximately $ 7 million. Serageldin assured Dr. Hafez that he was confident of his strategy in a conference call on the same date. Again Serageldin failed to inform Dr. Hafez of (1) his having changed the trading strategies respecting Prince Khalid's and the Foundation's accounts; (2) Beydoun's disagreement with and disapproval of the manner in which Serageldin traded; and (3) his intention to open new positions incurring even greater risk and generating additional commissions. The personal account of Prince Khalid was never discussed during the entire conversation.
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.
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 ...