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HASSAN v. SMITH BARNEY

December 10, 1985

Hassan and Farideh SHAHMIRZADI, Plaintiffs,
v.
SMITH BARNEY, HARRIS UPHAM & COMPANY, INC., and George Dow, Defendants



The opinion of the court was delivered by: HARRIS

 STANLEY S. HARRIS, District Judge.

 This matter is before the Court on the motion of the defendants Smith Barney, Harris Upham & Company, Inc., and George Dow "To Dismiss, To Compel Arbitration And To Strike Claim For Punitive Damages." The defendants seek dismissal of all claims for failure to state a cause of action, dismissal of all claims for statutory or common law fraud for failure to state with sufficient particularity the circumstances constituting the alleged fraud, dismissal of the claims under the antifraud provisions of the federal securities laws for failure to state a claim, and dismissal of all claims under the constitution or rules of the New York Stock Exchange (NYSE) or the National Association of Securities Dealers, Inc. (NASD) on grounds that those private industry rules do not create a private cause of action. The defendants also request that all pendent common law claims be referred to arbitration, and that the plaintiffs' claims for punitive damages be stricken.

 The Court denies the defendants' motion to dismiss for failure to state a claim, for failure to plead fraud and churning (i.e., excessive trading to generate commission income) with particularity, and failure to state a claim under the federal securities laws. The Court grants the defendants' motion to sever all claims not arising under the federal securities laws and refer them to arbitration, the defendants' motion to dismiss all claims arising under the rules of the NYSE or the NASD for failure to state a claim upon which relief may be granted, and the defendants' motion to strike the plaintiffs' claims for punitive damages.

 Background

 The plaintiffs allege that after Dow moved to Smith Barney, he induced them to invest an additional $100,000, obtained through a mortgage on their home, in securities and options. Dow promised them low risk and high return, perhaps as much as 45%, on their investment. Dow was aware that the plaintiffs had no experience in trading either securities or options. In 1981, the plaintiffs turned the money over to Dow, asking him to invest it conservatively. Dow instead invested it heavily in options and in securities purchased on margin.

 By January 1983, plaintiffs' non-bond portfolio had fallen to a value of $15,750. Plaintiffs instructed Dow to take more care and to seek advice from his superiors before trading further in their account. Dow indicated that he would follow these instructions; plaintiffs allege that he did not. When the value of their portfolio continued to decline, plaintiffs inquired about their account, but were told that the statements they had received were no longer current.

 In October 1983, plaintiffs met with Dow's superior at Smith Barney and asked for an investigation of Dow's handling of their account. Plaintiffs were told that an investigation would be undertaken and that they would be contacted within three days. The plaintiffs were never contacted, and they believe that Dow's conduct never was investigated. The value of the plaintiffs' portfolio continued to decline, and by November 1983 its value had reached only $248.

 In their amended complaint, the plaintiffs advance three counts for relief. All three of these counts are grounded upon violations of "the Rules and/or Constitution of the New York Stock Exchange and/or the National Association of Securities Dealers, Inc., the Securities Act of 1933 and the Securities Exchange Act of 1934, the rules and regulations of the Securities and Exchange Commission, and the fiduciary duty the Defendants owed the Plaintiffs."

 Count I alleges fraud on the plaintiffs by defendant Dow, which is chargeable to the defendant Smith Barney as Dow's employer. In Count II, the plaintiffs seek redress for the false or misleading statements made to them by Dow, and the omissions of material fact with respect to the risks of trading securities and options. Count III concerns the alleged churning of the plaintiffs' account based on the accrual within 26 months of $39,965 in commissions. The plaintiffs ask for rescission of the contract, compensatory damages, punitive damages, costs, and attorney's fees.

 A. Failure To State A Claim Upon Which Relief Can Be Granted

 In all three counts of their complaint, the plaintiffs' ground their claim for relief on violations of, inter alia, unspecified provisions of the "Rules and/or Constitution of the NYSE and/or the NASD. . . ." The defendants have moved to dismiss this part of plaintiffs' claims on grounds that no private right of action exists under those rules. The Court finds that no private right of action exists, and grants the defendants' motion to dismiss all claims for relief based on those provisions.

 A private right of action normally may be implied only where Congress intended to create such a cause of action. It is a question of statutory construction. Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 15, 100 S. Ct. 242, 245, 62 L. Ed. 2d 146 (1979); Touche Ross & Co. v. Redington, 442 U.S. 560, 575-76, 99 S. Ct. 2479, 2488-89, 61 L. Ed. 2d 82 (1979). The court in Touche Ross determined Congress' intent by examining the language of the statute, the legislative history of the statute, and the overall statutory scheme. Touche Ross, at 568-73, 99 S. Ct. at 2485-88.

 The NYSE and NASD rules at issue here, however, were not directly enacted by Congress. They were adopted by the NYSE and the NASD acting on the authority of Congress. Therefore, a two-step inquiry is necessary to determine whether there was legislative intent to create a private cause of action: (1) whether Congress intended to delegate authority to establish rules implying a private right of action, and (2) whether the rules were drafted such that a private right of action thereunder legitimately may be implied. Jablon v. Dean Witter & Co., 614 F.2d 677, 679 (9th Cir.1980). See also Walck v. American Stock Exchange, 687 F.2d 778, 788 (3d Cir.1982), cert. denied, 461 U.S. 942, 103 S. Ct. 2118, 77 L. Ed. 2d 1300 (1983).

 The Court finds that Congress did not intend to delegate the authority to create private causes of action, and therefore does not reach the issue of whether any particular exchange or association rule indicates an intent to create a private cause of action. *fn1"

 Prior to Touche Ross and Transamerica, some courts had implied causes of action from NYSE rules through the conjunction of §§ 6(b) and 27 of the Securities Exchange Act (SEA), 15 U.S.C. §§ 78f(b), 78aa (1981). Section 6(b) requires exchanges to develop rules promoting "just and equitable principles of trade." The duties created by these rules were held privately enforceable through § 27. Section 27 provides that any action may be "brought to enforce any liability or duty created by this chapter or the rules or regulations thereunder." See, e.g., Buttrey v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 410 F.2d 135 (7th Cir.), cert. denied, 396 U.S. 838, 90 S. Ct. 98, 24 L. Ed. 2d 88 (1969).

 Similarly, a private cause of action could be implied from the NASD rules through the conjunction of §§ 15A(b)(6) and 27 of the SEA, 15 U.S.C. §§ 78o-3(b)(6), 78aa (1981). Section 15A(b)(6) requires a stock exchange to adopt disciplinary rules. Those rules would then be enforceable through § 27.

 The Touche Ross Court rejected the idea that § 27 of the SEA created a private cause of ...


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