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United States District Court, N.D. Illinois

May 14, 2004.

KENNETH FOSS, Administrator of the Estate of Vincent P. Koth, Plaintiff

The opinion of the court was delivered by: MATTHEW KENNELLY, District Judge


Plaintiff, Kenneth Foss, is the administrator of the Estate of Vincent P. Koth; he has filed suit against Patrick O'Meara under Section 10(b) of the Securities Exchange Act and Rule 10b-5(a) and 10b-5(c) in connection with an alleged scheme to defraud Koth's estate of millions of dollars in securities. 17 C.F.R. § 240.10b-5(a), (c). Foss claims that O'Meara along with Authur McDonnell, who is not a party to this case, stole, converted, and sold securities belonging to Koth's estate, and kept the proceeds. Foss has also brought a common law claim against Bear, Sterns for negligent supervision of its employee, O'Meara, who was an account executive at Bear Sterns throughout most of the time period relevant to this suit. Bear, Sterns and O'Meara have moved to dismiss pursuant to Rule 12(b)(6). For the reasons stated below, the Court grants defendants' motion.


  Vincent P. Koth died on May 19, 1998, having accumulated a substantial amount of assets, which were represented by physical certificates of various corporations and governmental authorities. These certificates were registered in his name, or were in "bearer" form, and kept in safe deposit boxes in Chicago. He also maintained accounts with various issuers of securities where he owned a substantial amount of assets in the form of securities.

  After hearing of Koth's death, Authur McDonnell, a distant relative of Koth, and not an heir to his estate, applied to the Probate Division of the Circuit Court of Cook County to be appointed as administrator of the estate. On July 29, 1998, McDonnell was appointed the administrator of Koth's estate. According to plaintiff, McDonnell discovered the aforementioned certificates but did not report their existence to the probate court.

  In November 1998, McDonnell formed International Investments of Elgin, Inc. ("IIE"), which he incorporated in the state of Nevada. That same month McDonnell, along with his son-in-law, Patrick O'Meara, an account executive at Bear Stearns, caused a securities account to be opened at Bear Stearns for IIE. O'Meara, served as the account executive for the IIE account at Bear Stearns.

  Shortly after the account was opened, certificates representing assets of Koth's estate were received into the account of IIE. These certificates were registered on their face in the name of "Vincent P. Koth," "Vincent Koth," or "Vincent Patrick Koth." McDonnell obtained possession of these certificates in Chicago, and had them delivered to Bear Stearns in Boston. These certificates represented approximately $1,400,000 in assets of the Estate. Thereafter, additional assets of the Estate with an aggregate value of approximately $600,000 were received into the IIE account at Bear Stearns.

  Beginning on November 20, 1998, Bear Stearns performed the functions necessary to transfer record ownership of the assets of the Estate from the name of Vincent Koth, into an ownership form which permitted Bear Stearns to deliver the securities to complete a sale in the account for the exclusive benefit of IIE. On November 23, 1998, McDonnell and O'Meara began to sell the securities in the IIE account. By December 31, 1998, McDonnell and O'Meara had sold $1,101,411 of the securities in the account. According to plaintiff, McDonnell and O'Meara caused the proceeds received by HE from the sale of the securities to be transferred by Bear Stearns from the account of IIE to other accounts at Bears Stearns which were not for the benefit of the Estate.

  According to the plaintiff, McDonnell also discovered that Koth held assets in accounts at the issuers of securities or their agents which also belonging to the Estate. In order to gain control of these securities, McDonnell and O'Meara instructed Bear Sterns to again perform the functions necessary to have them transferred into an ownership form which permitted Bear Stearns to receive them directly into the account of HE, and to deliver them to complete their sale in the account of IIE for its exclusive benefit. Plaintiff asserts that during the period from November 20, 1998 to June 30, 2000, securities belonging to the Estate were received into the account of IIE at Bear Stearns, and sold for proceeds of $2,000,909, all of which have been disbursed from the account, and none of which returned to the Estate.

  Plaintiff further asserts that from November 1998 until April 2000, McDonnell and O'Meara used the proceeds from the sale of the assets of the Estate in the IIE account to purchase and sale securities in that account. The account was then liquidated, and the resulting cash balance was wire transferred by Bear Stearns to an account at First National Bank of Naples, Florida. McDonnell and O'Meara also caused Bear Stearns to finance the purchase and sale of securities by extending credit to IIE secured by the assets in the account which were not yet sold, or securities purchased with proceeds of the sale of those assets. During the period from November 1998 through September 1999, an aggregate of approximately $13,348,049 in securities were purchased in approximately 275 transactions. O'Meara, as the agent of Bear Stearns for the IIE account received substantial compensation from the transactions.

  In September 1999, O'Meara's association with Bear Stearns terminated. That same month, O'Meara became associated with R.K. Grace & Company in their Miami, Florida office. In October 1999, McDonnell opened an account at R.K. Grace in his own name. O'Meara was the agent for R.K. Grace for McDonnell's account. On October 20, 1999, approximately $50,000 of assets of the Estate were received into McDonnell's personal account at R.K. Grace.

  According to the plaintiff, McDonnell concealed the existence of assets of the Estate and their subsequent theft by, among other things, filing one or more false inventories with the Probate Court, and falsifying tax returns for Koth in order to conceal the fact of the investment income received by Koth from his large securities portfolio. During the winter of 2002, however, information came to the attention of an attorney for an heir of the Estate that Koth had an investment portfolio at the time of his death which had not been reported by McDonnell. Thereafter, an investigation was conducted which disclosed the existence of the IIE account at Bear Stearns.

  On May 30, 2002, McDonnell was removed as administrator and replaced by Calvin Foss, an heir to the Estate. Around September, 30, 2002, Foss obtained the account statements for IIE from Bear Stearns, as well as documents concerning the opening of the account. Using the identification from the account statements of the securities received into the account of IIE at Bear Stearns, he sought to establish the ownership by Koth of the securities contributed to the account. On December 10, 2002, Foss filed a Citation for Recovery of Property from Arthur McDonnell, alleging that McDonnell had converted or embezzled assets from the Estate. Calvin Foss died on January 28, 2003, and was replaced by Kenneth Foss on April 4, 2003. Kenneth Foss filed an amended Citation for Recovery of Property from McDonnell. On May 23, 2003 a judgment order was entered against McDonnell in favor of Koth's estate in the amount of $3,476,709.26. The amount represented the dollar value of assets found by the Probate Court to have been unlawfully converted and embezzled from the estate by McDonnell, plus pre-judgment interest.

  Kenneth Foss brings the current suit alleging that the defendants' conduct with respect to the securities belonging to the estate violated the federal securities laws promulgated in the Securities Exchange Act of 1934. Foss also contends that Bear Stearns breeched their common law duty to supervise O'Meara in order to avoid the conversion and theft of the Estate's assets. Bear Stearns and O'Meara contend that Foss's federal securities law claim as well as his common law claim are time-barred. Alternatively, they contend that even if the Court finds that these claims are timely, that they should still be dismissed for failure to state a claim.


  Dismissal under Rule 12(b)(6) is appropriate only if it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim that would entitle him to relief. Conley v. Gibson, 355 U.S. 41, 45-46 (1957); Kennedy v. Nat'l Juvenile Det. Ass'n, 187 F.3d 690, 695 (7th Cir. 1999). In considering the motion, the court accepts as true all well pleaded facts alleged in the complaint and draws reasonable inferences from those facts in favor of the plaintiff. Jackson v. E.J. Brach Corp., 176 F.3d 971, 977 (7th Cir. 1999); Zemke v. City of Chicago, 100 F.3d 511, 513 (7th Cir. 1996). Federal Rule of Civil Procedure 9(b) requires "all averments of fraud" to be "stated with particularity," although "[m]alice, intent, knowledge, and other conditions of mind of a person may be averred generally." In a case involving alleged fraudulent misrepresentations, "[t]he rule requires the plaintiff to state the identity of the person who made the misrepresentation, the time, place, and content of the misrepresentation, and the method by which the misrepresentation was communicated to the plaintiff." Vicom, Inc. v. Harbridge Merch. Servs., Inc., 20 F.3d 771, 777 (7th Cir. 1994); see also DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir. 1990) ("Although states of mind may be pleaded generally [under Rule 9(b)], the `circumstances' must be pleaded in detail. This means the who, what, when, where, and how: the first paragraph of any newspaper story."). In addition, the Private Securities Litigation Reform Act of 1995 (PSLRA), added to the Securities Exchange Act a requirement that the plaintiff's complaint "specify each statement alleged to have been misleading," and "the reason or reasons why the statement is misleading." 15 U.S.C. § 78u-4(b)(1), as well as a requirement that as to each misstatement or omission, the complaint "state with particularity the facts giving rise to a strong inference that the defendant acted with the required state of mind." Id. at § 78U-4(b)(2).

  Defendants seek dismissal of both Foss's federal securities law claim as well as his claim of negligent supervision arising under common law. Defendant claims that both claims are time barred and alternatively that they fail to state a claim for which relief may be granted. With respect to Foss's federal securities claim, the defendants argue that Rule 10b-5 claims are governed by a one-year statute of limitations and a three-year statute of repose. Defendants contend that plaintiff missed the applicable statute of limitations by one day, and therefore the Court should dismiss this claim as untimely. Foss concedes that this claim is time-barred, but contends that Congress' enactment of the Sarbanes-Oxley Act in 2002, which enlarged the statute of limitations and statute of repose for federal securities fraud cases to 2 and 5 years respectively, was intended to be applied retroactively. Foss contends that the language of the act suggests that it was meant to cover cases that would have been time-barred at the date the statute was enacted but where the proceedings were commenced on or after the date the statute took effect.

  Defendants also contend that Foss fails to state a cause of action under federal securities law. Defendants claim that Foss has failed to adequately plead any of the elements necessary to state a claim under § 10b of the Securities Exchange Act. Foss claims that he is proceeding under Rules 10b-5(a) and (c) of the act, and have sufficiently plead claims under these provisions. Foss claims that the elements of a cause of action under Rule 10b-5(a) and 10b-5(c) are different from those required under Rule 10b-5(b). He claims that because he is alleging liability under Rule 10b-5(a) and (c) he is not required to plead all of the elements of a 10b-5(b) claim as the defendants suggest. The Court disagrees, and for the reasons discussed below grants defendants' motion to dismiss Foss' claims.

  We begin or analysis with the text of the statute and regulation at issue. Section 10(b) of the federal securities laws prohibits, "in connection with the purchase or sale of any security," the use of any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [Securities Exchange Commission] may prescribe." The SEC has prescribed Rule 10b-5, which makes it unlawful for any person:

(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.
17 C.F.R. § 240.10b-5.

  In Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A. 511 U.S. 164 (1994), the Supreme Court severely restricted the types of actions that could be brought under § 10(b). The Court held that the language of § 10(b) could not be read to imply a private cause of action against those who merely aid and abet a § 10(b) violation. Id. at 1448. Thus, only those persons who performed acts specifically proscribed by § 10(b) — primary violators — can be held liable. Plaintiff does not allege that O'Meara helped McDonnell commit the fraudulent acts, but that the he is primarily liable for the losses to the estate under § 10(b) and Rule 10b-5. To state a valid Rule 10b-5 claim, a plaintiff must allege that the defendant (1) made a misstatement or omission, (2) of material fact, (3) with scienter, (4) in connection with the purchase or sale of securities, (5) upon which the plaintiff relied, and (6) that reliance proximately caused the plaintiff's injuries." In Re HealthCare Compare Corp. Sec. Litig., 75 F.3d 276, 280 (7th Cir. 1996). Absent from Foss' complaint, however, is any allegation that O'Meara actually made material misstatements to Foss, or failed to disclose certain information when duty-bound to do so. Also absent are any allegations that Foss relied on any such misstatement or omission, or that such reliance caused the injuries Foss suffered. Foss contends that notwithstanding the numerous cases that cite to the above language, that no such allegations are required for claims brought under Rules 10b-5(a) and (c).

  The only case Foss cites in support of his proposition that he need not allege specific misrepresentations, reliance or causation is In re Initial Public Offering Securities Litigation, 241 F. Supp.2d 281 (S.D.N.Y. 2003). This case, however, is of no help to plaintiff. In that case, plaintiffs alleged a vast market manipulation scheme surrounding the issuance of IPO's for hundreds of high technology and internet-related companies. The plaintiffs claimed that investment banks, companies, underwriters, issuers, and individual officers, all conspired to defraud the investing public by driving up the price of stock in these companies in the immediate aftermarket of their IPO. In examining the sufficiency of the complaint, the court discussed the applicability of the PSLRA and FRCP 9(b) to the various elements of a 10b-5 claim. It concluded that market manipulation claims that did not rely on misstatements or omissions need not satisfy paragraph (b)(1) of the PSLRA, which requires that a complaint "specify each statement alleged to have been misleading," and "the reason or reasons why the statement is misleading," but were still required to satisfy paragraph (b)(2) which requires that the plaintiff "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(1).

  Thus, in holding that a market manipulation claim that does not rely on misstatements or omissions need not satisfy paragraph (b)(1) of the PSLRA the court merely clarified the specificity with which the elements necessary to establish a 10b-5 claim must be plead. As the court explained, claims of market manipulation do not necessarily require proof that defendants made any material misstatements or omissions. Id. at 277 n.100 citing 17 C.F.R. § 240.10b-5(a),(c). However, Foss does not allege a market manipulation theory. In any event, as the Court discusses below, that theory is inapplicable here. Moreover, the court still went on to analyze whether the plaintiff pled the remaining elements of a Rule 10b-5 claim, including reliance, and resulting damage from such reliance both in the context of his material misstatement claim as well as his claim under a market manipulation theory. Id. at 386 ("I have already held in the material misstatement context that Plaintiffs have alleged transaction and loss causation, which also include the elements of damage and reliance . . . [T]hat analysis applies with equal force in the market manipulation context.") Thus, this case does not excuse Foss from pleading all of the established elements of a 10b-5 claim, even when proceeding under Rule 10b-5(a) and (c) rather than Rule 10b-5(b).

  Under the facts of this case, Foss would not be able to establish a claim for a 10b-5 violation under a market manipulation theory. Market manipulation refers to tactics by which traders, like monopolists, create artificially high or low prices, that do not reflect the underlying conditions of supply and demand. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 199 (1976). O'Meara's alleged conduct of stealing, converting, and selling securities belonging to Koth's estate, cannot fathomably be construed as attempting to alter the condition or prices in the market. Foss does not allege any other theory of recovery. Nor does he set forth the elements, other than the scienter, and "in connection with" requirements, necessary to establish his claim under 10b-5(a) and 10b-5(c). These elements alone are not sufficient to establish a claim under the act. See, e.g., SEC v. U.S. Environmental, Inc., 897 F. Supp. 117, 120 (S.D.N.Y. 1995) ("The defendant's personal involvement in a scheme or plan to violate the Securities Acts, without more, is insufficient."); In The Matter of Lake States Commodities, Inc., 936 F. Supp. 1461, 1472 (N.D. Ill. 1996) (rejecting claims where plaintiff merely plead "device, scheme, or artifice to defraud," and "engaged in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person," as insufficient to state a claim under 10b-5(a) and 10b-5(c).); Stack v. Lobo, 903 F. Supp. 1361, 1374 (N.D. Cal. 1995) (rejecting "scheme to defraud" allegations as insufficient under § 10(b)); Continental Casualty Co. v. State of New York Mortgage Agency, 1994 WL 532271, at *2-3 (N.D. Ill. 1994) (rejecting claim of "device, scheme and artifice" to defraud where plaintiff failed to allege misrepresentation or deception).

  Foss, therefore, has provided the Court with no authority to suggest that he is only required to plead scienter and that O'Meara's conduct was done "in connection with" a securities transaction. Moreover, in light of the vast array of case law that suggests otherwise, the Court agrees with the reasoning of the Southern District of New York that a plaintiff must allege and prove all of the established elements of a 10b-5 claim, even when proceeding under Rule 10b-5(a) and (c) rather than Rule 10b-5(b). In re Towers Financial Corporation Noteholders Litigation, 1995 WL 571888, *16 (S.D.N.Y.) citing SEC v. U.S. Environmental, Inc., 1995 WL 505890 at *3 (S.D.N.Y.). Consequently, in addition to alleging that Foss acted with scienter and that his conduct was "in connection with" a securities trasaction (which the Court makes no determination as to the sufficiency of Foss' allegations on these elements), Foss is also required to plead the remaining elements of a 10b-5 violation. These elements include an allegation that O'Meara made a misstatement or omission where he was duty-bound to disclose such information. In the absence of such an allegation, Foss is required to allege market manipulation or some other theory in which pleading a misstatement or omission would not be required. Additionally, Foss is required to demonstrate that he relied on such misstatement or omission, and that such reliance caused his injuries. Since his complaint is admittedly devoid of such allegations, the Court must dismiss his claim on this issue. This conclusion is consistent with the Supreme Court's statement in Central Bank of Denver, that "any person or entity . . . who employs a manipulative device or makes a material misstatement (or omission) on which a purchaser or seller of securities relies may be liable as a primary violator under 10b-5, assuming all of the requirements for primary liability under Rule 10b-5 are met." 114 S.Ct. at 1455 (emphasis in original).

  Equally fatal to Foss' claim, however, is that he fails to allege that O'Meara engaged in any deception or manipulation with respect to the alleged securities transactions. Allegations that the defendant engaged in deceptive or manipulative conduct is required to state a claim under § 10(b). 15 U.S.C. § 78j; Central Bank of Denver, 511 U.S. 164, 177-78; Chiarella v. United States, 445 U.S. 222, 232 (1980). Examining the controlling caselaw on these issues as they relate to securities fraud clearly demonstrates that Rule 10b-5 does not contemplate the type of conduct Foss alleges O'Meara engaged in. Manipulation in the securities fraud context refers to conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities. See Ernst & Ernst, 425 U.S. at 199; see also Sante Fe Indus., Inc. v. Green, 430 U.S. 462, 476 (1977) ("Manipulation is virtually a term of art when used in connection with securities markets. The term refers generally to practices, such as wash sales, matched orders, or rigged prices, that are intended to mislead investors by artificially affecting market activity." As the Supreme Court has explained, most forms of "manipulation" involve deception in one form or another. Santa Fe, 430 U.S. at 476-77'. Even where as here, the plaintiff's claim does not rely on misstatements or omissions, courts have required plaintiffs to allege that defendants engaged in some deceptive or manipulative conduct in order to sustain a 10b-5 claim. See e.g., In re Initial Public Offering Securities Litigation, 241 F. Supp.2d at 390 (plaintiffs had sufficiently plead deceptive or manipulative conduct because they alleged a scheme the purpose of which was to artificially raise stock prices above their true value.)

  The conduct at issue here clearly does not satisfy the established standard with respect to pleading deception or manipulation. As previously discussed, Foss did not investor in any securities. Further, the Court does not see how O'Meara's alleged acts of stealing, converting, and selling securities belonging to Koth's estate could in any way be interpreted as attempting to artificially affect the price of securities in the market. Foss's claims against O'Meara seeks to expand 10b-5 beyond its text and accompanying case law. "[A] court should be reluctant to imply a 10b-5 cause of action for wrongs that do not fall within § 10(b)'s fundamental purpose of requiring full and fair disclosure to participants in securities transactions of the information that would be useful to them in deciding whether to buy or sell securities." O'Brien v. Continental Illinois National Bank and Trust Co. of Chicago, 593 F.2d 54, 60 (7th Cir. 1979) (citing Santa Fe, 430 U.S. at 477-78). Allowing Foss to proceed with his claim against O'Meara do not fulfill Congress' purpose in adopting the Securities Exchange Act, and therefore warrants dismissal. Sante Fe, 430 U.S. at 477.

  As the Court has dismissed Foss's federal securities claim against O'Meara on the grounds that it fails to state a cause of action under federal securities law, the Court declines to address the question of whether Congress' enactment of the Sarbanes-Oxley Act was meant to apply retroactively to plaintiff's admittedly time-barred securities claim. Moreover, the Court declines to exercise supplemental jurisdiction over Foss' common law negligent supervision claim against Bear Stearns as this issue is best left to the state courts to decide.

  Conclusion For the reasons stated above, defendants' motion to dismiss [docket # 3] is granted. The Clerk is directed to enter judgment in favor of the defendants.


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