Opinion
95 Civ. 10742 (SWK)
July 18, 2001
APPEARANCES:
For Plaintiffs: Lovell Stewart, LLP, New York, New York, By: Christopher Lovell; Jonathan Kord Lagemann, Esq., New York, New York
For Defendants: Sidley Austin Brown Wood, New York, New York, By: A. Robert Pietrzak
MEMORANDUM OPINION AND ORDER
Before the Court is Defendants' motion (the "Motion"); pursuant to Federal Rules of Civil Procedure 12(b)(1), 12(b)(6) and 9(b), to dismiss the second amended class action complaint (the "Second Amended Complaint") in the above-captioned matter. For the reasons set forth below, the motion is denied in part, and granted in part.
BACKGROUND
As indicated below, the facts of this long-standing litigation are set forth in several previous opinions. Familiarity with these decisions, the procedural history of this matter, and the facts of the case are presumed.
On July 22, 1997, the Court dismissed Plaintiffs' first amended class action complaint (the "First Amended Complaint") pursuant to Federal Rule of Civil Procedure 12(b)(6), on the grounds that Merrill Lynch was under no statutory or regulatory duty to disclose markups on municipal securities. See Grandon v. Merrill Lynch Co., No. 95 Civ. 10742, 1997 WL 411924, at *5-7 (S.D.N.Y. July 22, 1997) ("Grandon I"). On June 19, 1998, the Court of Appeals for the Second Circuit vacated Grandon I, and held, inter alia, that "there exists an implied duty to disclose markups on municipal securities when those markups are excessive." Grandon v. Merrill Lynch Co., 147 F.3d 184, 193 (2d Cir. 1998) ("Grandon II"). The Court of Appeals left, it to this Court to determine whether the First Amended Complaint stated a claim of fraudulent undisclosed markups. By opinion dated November 1, 1999, the Court again dismissed the First Amended Complaint, on the grounds that "plaintiffs fail[ed] to state a claim for fraudulent undisclosed markups." Grandon v. Merrill Lynch Co., No. 95 Civ. 10742, 1999 WL 993653, at *4 (S.D.N.Y. Nov. 1, 1999). ("Grandon III"). The Court, however, expressly allowed Plaintiffs to file a second amended complaint in order to conform to the standards set forth in Grandon II. On November 17, 1999, Plaintiffs submitted the Second Amended Complaint that is the subject of the instant motion.
The Second Amended Complaint alleges, inter alia, that Merrill Lynch charged Plaintiffs excessive markups when they purchased municipal bonds from Merrill Lynch on three occasions (in four transactions) in 1994 and 1995. See Grandon I, 1997 WL 411924, at *1-2 (detailing transactions);Grandon III, 1999 WL 993653, at *1-2 (same). Defendants filed the instant motion and an accompanying memorandum of law on April 10, 2000. See Memo. of Law in Support of Defs.' Mot. to Dismiss the Second Am. Compl. ("Defs.' Memo."). Plaintiffs filed their memorandum in opposition to the Motion On June 30, 2000. See Pls.' Memo. of Law in Opp. of Defs.' Mot. ("Pls.' Memo."). Defendants filed their reply on July 24, 2000. See Defs.' Memo. of Law in Supp. of Defs.' Mot. to Dismiss the Second Am. Compl. ("Defs.' Reply"). On September 26, 2000, all briefing on the Motion closed with the submission of Plaintiffs' surreply memorandum.See Pls.' Surreply Memo. Filed Pursuant to the Court's August 14, 2000 Memo Endorsement Regarding the Limited Issue of Systematically Charging Higher Markups for Municipal Bonds than for Equities ("Pls.' Surreply"). The Court has carefully considered all of these materials before rendering its decision.
All citations refer to the "Corrected Copy" of this brief, filed by Plaintiffs on June 30, 2000.
DISCUSSION
I. Standard of Law
On a motion to dismiss brought pursuant to Rule 12(b)(6), the Court must accept the allegations in the complaint as true and construe them in the light most favorable to the plaintiffs. Easton v. Sundram, 947 F.2d 1011, 1014-15 (2d Cir. 1991), cert. denied, 504 U.S. 911 (1992). A complaint should not be dismissed "unless 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).
To state a claim under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j, and Rule 10b-5 promulgated thereunder, plaintiffs must allege: (1) a material misstatement or omission, (2) made with scienter, (3) in connection with a purchase or sale of securities, (4) upon which the plaintiff relied, (5) which caused plaintiff injury.See Grandon II 147 F.3d at 189; In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 264 (2d Cir. 1993). Further, Federal Rule of Civil Procedure 9(b) requires that "the circumstances constituting fraud or mistake . . . be stated with particularity." Fed.R.Civ.P. 9(b). The Private Securities Litigation Reform Act of 1995 (the "PSLRA"), 15 U.S.C. § 78u-4, "ma[de] even more stringent the [nationwide] pleading standard for each of the above elements than was generally required previously" by Rule 9(b). Castillo v. Dean Witter Discover Co., No. 97 Civ. 1272, 1998 WL 342050, at *4 (S.D.N.Y. June 25, 1998) ("Castillo").
Section 10(b) prohibits the use of "any manipulative or deceptive device or contrivance" in connection with the purchase or sale of securities. See 15 U.S.C. § 78(j).
The Second Amended Complaint alleges, inter alia, that Merrill Lynch violated Section 10(b) by failing to disclose markups in connection with the sale of municipal bonds to Plaintiffs, and by making various misrepresentations in connection with the sale of said bonds. Thus, Plaintiffs must satisfy the stringent pleading requirements of Rule 9(b) and the PSLRA. See generally Novak v. Kasaks, 216 F.3d 300, 307-10 (2d. Cir. 2000) ("Novak"). The PSLRA raised the nationwide pleading standard to that previously employed in the Second Circuit. See id. at 310. "Plaintiffs must `state particularity facts giving rise to a strong inference that the defendant acted with the required state of mind,' as required by the language of the [PSLRA] itself." Id. at 311 (quoting 15 U.S.C. § 78u-4(b)(2)). Such an inference arises where a plaintiff alleges either (1) facts showing that defendants had both motive and opportunity to commit fraud, or (2) facts constituting strong circumstantial evidence of conscious misbehavior or recklessness. See Rothman v. Gregor, 220 F.3d 81, 90 (2d Cir. 2000). The case law in this circuit indicates that the required inference arises where the complaint sufficiently alleges that the defendants: (1) benefitted in a concrete and personal way from the purported fraud; (2) engaged in deliberately illegal behavior; (3) knew facts or had access to information suggesting that their public statements were not accurate; or (4) failed to check information they had a duty to monitor. Novak, 216 F.3d at 311.
II. Plaintiffs' First Cause of Action
A. Fraudulent Undisclosed Markups
In Grandon II, the Court of Appeals held that "a private action under the antifraud provision of Section 10(b) and Rule 10b-5 exists against broker-dealers who charge undisclosed, excessive markups on municipal bonds." Grandon II, 147 F.3d at 193. Thus, the duty to disclose markups on bonds is triggered when markups are "excessive." See id. at 190; see also Press II, 166 F.3d at 532. In general, a markup is excessive "when it bears no reasonable relation to the prevailing market price." Grandon II, 147 F.3d at 190 (quoting Bank of Lexington Trust Co. v. Vining-Sparks Secs., Inc., 959 F.2d 606, 613 (6th Cir. 1992)). Courts determine whether markups are excessive on a case-by-case basis. See id. at 193. Furthermore, "courts should begin [the analysis of `excessive' markups] with the factors set forth under MSRB Rule G-30." Id. at 193. While the determination is generally fact-based, "in some cases a trial court, as a matter of law, properly may conclude that a plaintiff has failed to state a claim that the markups were excessive." Id.
The Municipal Securities Rulemaking Board ("MSRB") is a self-regulating organization created by Congress in 1975, and supervised by the SEC. See Grandon II, 147 F.3d at 191. The MSRB is the primary regulatory authority in the municipal securities market. See id. MSRB Rule G-30 requires that prices charged by a municipal securities dealer be "fair and reasonable, taking into account all relevant factors."Id.
Plaintiffs' first cause of action alleges that Merrill Lynch violated Section 10(b) of the Securities Exchange Act and Rule 10b-5 by charging hidden, excessive markups on, municipal bond transactions. Specifically, Plaintiffs allege that Merrill Lynch charged hidden markups between 3.0% and 9.74% above "the true market price" of three types of bonds. See Second Amended Complaint, ¶¶ 41(b), 43(c), 45(b), 46, 48(b), and 49. To support their claim of fraudulent markups, Plaintiffs make several additional allegations in the Second Amended Complaint. First, Plaintiffs allege that the secondary market for municipal bonds is "opaque," meaning that market prices for municipal bonds are "clear and known to broker-dealers but are not clear, known or generally available to public, retail customers." Id., ¶ 19. Thus, Plaintiffs claim that they are unable to definitively ascertain the specific markups charged, but that they have "good grounds" to believe that the markups were excessive for other reasons. See id., ¶¶ 44(a), 47(a), and 50(a). Second, Plaintiffs assert that Merrill Lynch knowingly charged fees on the municipal bond sales that were "substantially higher than the fees or markups which Merrill Lynch charged its customers for equity securities of the same or similar dollar size and amount." Id., ¶ 23. Plaintiffs allege that Merrill Lynch owed its customers a legal duty to ensure that the markups or fees it charged on the bonds are significantly lower than those for equity securities of similar dollar size. Id., ¶ 22., Third, Plaintiffs allege that after they purchased certain bonds, interest rates declined, but that the price of these bonds declined when they should have increased, and "the fact that the bond[s] declined in price can only be explained by the excessive markup[s] which Merrill Lynch charged." Id., ¶ 43(c); see also id., ¶ 43(a)-(b).
Plaintiffs further allege that the markups on the bonds were excessive when analyzed with respect to the criteria set forth in MSRB Rule G-30. The MSRB factors are:
(1) the best judgment of the broker, dealer or municipal securities dealer as to the fair market value of the securities at the time of the transaction; (2) the expense involved in effecting the transaction; (3) the fact that the broker, dealer, or municipal securities dealer is entitled to a profit; (4) the total dollar amount of the transaction; (5) the availability of the security in the market; (6) the price or yield of the security; and (7) the nature of the professional's business.Grandon II, 147 F.3d at 190; see also Press II, 166 F.3d 535. Plaintiffs make allegations concerning each of these factors.
First, Plaintiffs allege that because the bonds were "recently and publicly issued in significant size and w[ere]. of the highest credit," the bonds were "readily available" and therefore "the markup on the bond[s] should have been substantially less than 1%." Second Amended Complaint, ¶¶ 44(c)(1), 47(c)(1), and 50(c)(1) Second, Plaintiffs allege that the expenses involved in effecting the transactions were minimal, and assert that the markups should have been less than 1%. See id., ¶¶ 44(c)(2), 47(c)(2), and 50(c)(2). For example, plaintiffs allege, inter alia, that it took Merrill Lynch "less than one minute" to execute an order received by a customer; and that Merrill Lynch's standard clearing charge was $25.00 for a retail bond transaction. Id. Third, Plaintiffs allege that "the dollar amount [of the transactions] w[ere] well in excess of $5,000," and that the size of the transactions were sufficient to avoid special considerations mandating a markup higher than 1%. Id., ¶¶ 44(c)(3), 47(c)(3), and 50(c)(3).
Fourth, Plaintiffs allege that "there was very little room" for Merrill Lynch to use its business judgment in pricing the bonds above 1%, because the bonds were low risk, highly rated, insured, recently issued, and were part of large issuances. Id., ¶¶ 44(c)(4), 47(c)(4), and 50(c)(4). Fifth, Plaintiffs allege that "Merrill Lynch could profitably clear [these] bond transactions for [a fee of] $25.00 per bond[,]" and that, because of the high credit rating and insured nature of the bonds, a markup of 1% or less; would have produced "ample profits." Id., ¶¶ 44(c)(5), 47(c)(5), and 50(c)(5). Sixth, Plaintiffs allege that the excessive undisclosed markups cost them over the life of each bond between $2,045.00 and $3,086.00, compared to a markup of 1%. See id., ¶¶ 44(c)(6), 47(c)(6), 50(c)(6). Finally, Plaintiffs allege that Merrill Lynch "is the biggest purchaser and seller of municipal bonds in the United States," id., ¶ 44(c)(7), and that, given Merrill Lynch's economies of scale and purchasing power, the markup on these bonds "should have been substantially less than 1%." Id., ¶¶ 44(c)(7), 47(c)(7), and 50(c)(7).
Defendants argue that Plaintiffs have failed to state a claim on which relief could be granted because they do not specify the prevailing market price of the bonds. See generally Defs.' Memo. at 10-11; Defs.' Reply at 1-3. It is well-established that "[t]he markup on a security is the difference between the price charged to the customer and the prevailing market price." Grandon II, 147 F.3d at 189 (citing SEC v. First Jersey Securities, Inc., 101 F.3d 1450, 1469 (2d Cir. 1996)). Defendants allege that "[a] plaintiff in an `excessive markup' case must allege with particularity the prevailing market price that serves as the denominator of the markup formula," Defs.' Memo. at 11, and that "[a]s a matter of law, Plaintiffs' percentages are not markups at all because they. are based on something other than the two essential components of a markup."Id. at 13.
The Court of Appeals, however, has never mandated that a plaintiff must plead the precise prevailing market price of a security in order to state a claim for fraudulent undisclosed markups. In Grandon II, the court stated that "[t]he prevailing market price generally means the price at which dealers trade with one another, i.e., the current inter-dealer market." Grandon II, 147 F.3d at 189 (emphasis supplied) (internal quotation omitted). The Court of Appeals has also stated that, when a dealer is not a marketmaker — and Plaintiffs do not allege that Merrill Lynch is a marketmaker — "a dealer's contemporaneous cost is the best evidence of the current market." Id. (emphasis supplied) (internal citation omitted). Nowhere has the Court of Appeals held that a dealer's contemporaneous cost is the only evidence of the current market, or that a plaintiff must allege the price at which dealers trade with one another to support a claim of fraudulent markups. Indeed, the Court of Appeals has expressly advocated a flexible approach to the markup inquiry, and has stated that "[w]hether a markup is excessive must be determined on a case-by-case basis." Grandon II, 147 F.3d at 190. Other courts have held that "[i]n making this determination, the finder of fact must assess various factors, including, but not limited to, industry practice regarding the range of appropriate markups on a particular security or similar type of security in comparable transactions." SEC v. Feminella, 947 F. Supp. 722, 729 (S.D.N.Y. 1996) (emphasis supplied) (internal citations omitted)
In this case, Plaintiffs have adequately stated a claim upon which relief can be granted, because they allege, with specific reference to the MSRB factors, facts that, if proven, would show that Merrill Lynch charged Plaintiffs excessive undisclosed markups on the bonds in question. See Grandon II, 147 F.3d at 193 (stating that "courts should begin [the analysis of potentially fraudulent markups] with the factors set forth under MSRB Rule G-30"). As set forth above, Plaintiffs have alleged, inter alia, that (1) the expense in effecting the bond transactions was minimal, or $25.00 per transaction; (2) the bonds were recently issued, insured, readily available, and purchased in transactions of significant size; (3) Merrill Lynch typically charged markups of between .33% and 1.3% for equity transactions of similar dollar size and amount; (4) Merrill Lynch owed its municipal bond customers a duty to charge fees on the bonds that were significantly lower than those for equity securities of similar dollar size; and yet (5) Merrill Lynch charged markups of between 3.0% and 9.74% above the true market price of these bonds, thereby reaping grossly excessive profits. Thus, accepting Plaintiffs' allegations as true, the broker-dealer industry standard for markups on municipal bonds was to charge "significantly less" than the markups charged for equities of similar size, but Merrill Lynch knowingly violated this standard by charging municipal bond customers hidden fees in excess of this standard. See Second Amended Complaint, ¶¶ 22-22, 44, 47, 50. The Court finds that these allegations are sufficient to properly state a claim of excessive, undisclosed markups in violation of Section 10(b) and Rule 10b-5, provided the particularity requirements of Federal Rule of Civil Procedure 9(b) are met.
This Court previously found, in connection with the First Amended Complaint, that "a reasonable investor would have considered disclosure of the fees [in question] important," and that "Merrill Lynch's purported omissions were material." Grandon I, 1997 WL 411924 at *4 Likewise, the Second Amended Complaint adequately pleads the materiality requirement of Rule 9(b), and the Court's finding remains unchanged. The Court also found that "[p]ossession of the [purportedly] omitted information as to the true market price and fee could well have induced plaintiffs to seek better terms from Merrill Lynch or other brokers." Id. at *5 Thus, "[b]ecause no affirmative statements were made by Merrill Lynch, the Court finds that a presumption of reliance is warranted." Id. This finding remains unchanged as well.
B. Particularity of Allegations
The Second Amended Complaint must satisfy the stringent pleading requirements of Federal Rule of Civil Procedure 9(b) and the PSLRA. Plaintiffs must specify the fraudulent acts, including who is responsible for the acts, when and where they were performed, and why they are fraudulent. See, e.g., Rubinstein v. Skyteller, 48 F. Supp.2d 315, 319-20 (S.D.N.Y. 1999). Plaintiffs must also "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)(2).
The Court finds that the Second Amended Complaint provides sufficient detail regarding the fraudulent acts for which Plaintiffs seek redress. Plaintiffs specify four transactions, and allege that the hidden markups on the bonds averaged between 3.0% and 9.74% above their true market price, when the markups should have been less than 1.0% above the bonds' true market price. Furthermore, Plaintiffs supply the bases for their estimates of the "true market price," including Merrill Lynch's own monthly statement for one of the transactions. See Second Amended Complaint, ¶ 41(b). The Second Amended Complaint specifies the officers of Merrill Lynch who purportedly caused Merrill Lynch to systematically increase the markups charged on municipal bonds in violation of federal law, and it identifies their respective office locations. See id., ¶¶ 24-25. The times and dates of the transactions in question are also specified.
In all other cases, "[t]he true market price was determined from yields quoted in the Wall Street Journal for municipal securities of similar credit, maturity and trading characteristics." Second Amended Complaint, ¶ 41(b).
Finally, with respect to scienter, the Second Amended Complaint alleges facts which show that Merrill Lynch had both motive and opportunity to commit fraud. See Rothman v. Gregor, 220 F.3d 81, 90 (2d Cir. 2000). Defendants allegedly knew facts and had access to information which suggest that Defendants made deceptive and fraudulent omissions in connection with the bond transactions. See Novak, 216 F.3d at 311. As noted above, Plaintiffs allege that Merrill Lynch, by and through specified officers, knew that Plaintiffs were paying excessive hidden markups on municipal bond transactions. These officers allegedly knew that Merrill Lynch had a "captive market" for the excessively priced municipal bonds because of the "opaque" secondary market for the bonds.See Second Amended Complaint, ¶ 24. That is, unlike most securities, Plaintiffs could not obtain, through an exchange or otherwise, real-time quoted prices of the bonds. See id., ¶ 19. Merrill Lynch allegedly instituted and maintained the practice of charging excessive markups on the bonds in order to increase "by at least tens of millions of dollars its revenues from municipal bond transactions," and, by extension, increase the compensation of Merrill Lynch's officers. Id., ¶ 32. The Court finds that these allegations, in the context of the allegations discussed above, meet the scienter requirements of Rule 9(b) and the PSLRA.
For all of the foregoing reasons, the Second Amended Complaint pleads, with the requisite degree of particularity, a cause of action for fraudulent undisclosed markups. Accordingly, and for all the reasons set forth above, Defendants' motion to dismiss the first cause of action of the Second Amended Complaint is denied.
III. Plaintiffs' Second Cause of Action
The Second Amended Complaint also pleads that Merrill Lynch made implied misrepresentations and various omissions that violated Section 10(b) and Rule 10b-5. See generally Second Amended Complaint, ¶¶ 61-63. Specifically, Plaintiffs allege that Merrill Lynch, by disclosing a $4.85 "Processing Fee" while simultaneously leaving blank a box on the confirmation statements marked "Markup/Markdown," impliedly misrepresented that the only compensation Defendants received from Plaintiffs' bond purchases was the $4.85 fee. See id., ¶¶ 27-29, 62(a). Plaintiffs also allege that, in violation of MSRB Rule G-15, Merrill Lynch failed to disclose to Plaintiffs whether it acted in an agency or principal capacity in effecting the municipal bond transactions. See id., ¶¶ 31(b), 62(b)(1) (2). Finally, Plaintiffs allege that Merrill Lynch failed to disclose that the markups that Merrill Lynch charged for the sales of municipal bonds were greater than the fees which Merrill Lynch charged for equity transactions of similar dollar size. See id., ¶ 62(3).
In Grandon III, the Court dismissed the First Amended Complaint without specifically addressing Plaintiffs' implied misrepresentation claim. Defendants argue that the Court thereby "disposed of this claim, which was presented in paragraph 33 of the Amended Complaint." Defs.' Reply at 14. However, Plaintiffs promptly moved for reconsideration of the Court's Order dismissing the Amended Complaint, and the Court deferred addressing the issue of the implied misrepresentation claim until submission of the Second Amended Complaint and consideration of the instant motion.
At this time, the Court grants Plaintiffs' motion for reconsideration, and considers the implied misrepresentation claim in this Memorandum Opinion and Order. The Court mistakenly overlooked the directive of the Court of Appeals to consider this claim. See Grandon II, 147 F.3d at 194.
Subsequent to the filing of the Second Amended Complaint, Plaintiffs "withdr[ew] and voluntarily dismiss[ed] so much of their Second Claim as was based upon Merrill's failure to disclose its capacity as principal or agent in the confirmation statements." Pls.' Memo, at 41 n. 10. The Court accepts Plaintiffs' withdrawal of this claim, and therefore, that portion of the Second Cause of Action alleging that Merrill Lynch unlawfully failed to disclose whether it acted as agent or principal in the transactions, is hereby dismissed.
In order to state a claim under Section 10(b) and Rule 10b-5, an "alleged misrepresentation . . . must go to either the value of the securities themselves or the nature of the consideration." SEC v. Feminella, 947 F. Supp. 722, 731 (S.D.N.Y. 1996) (citing Chemical Bank v. Arthur Andersen Co., 726 F.2d 930 (2d Cir. 1984) ("Chemical Bank"),cert. denied, 469 U.S. 884 (1984)). In Grandon II, the Court of Appeals observed that "[w]hile Merrill Lynch's confirmation statements have a box denoted `charge or markup/down,' that box is left blank, thereby suggesting, if not indicating, that no markup was charged." Grandon II, 147 F.3d at 194. Defendants assert that it is unreasonable as a matter of law for Plaintiffs to have purchased the bonds without knowing that some markup would be charged and that, as a result, the blank "markup" box cannot support a claim for fraudulent misrepresentation. See Defs.' Memo. at 24-25; Defs.' Reply at 15-16. In support of their argument, Defendants cite Press v. Chemical Inv. Serv. Corp., where the court held that "it is completely unreasonable objectively for [plaintiff] to have believed that the defendants were executing his securities transaction at cost, i.e., that they were not charging him any fee in return for the provision of their services." 988 F. Supp. 375, 384 n. 11 (S.D.N.Y. 1997) ("Press I").
The instant case, however, differs from Press I in that Merrill Lynchdid disclose a $4.85 "processing fee" in the appropriate box while simultaneously leaving the "markup" box blank. While Defendants argue that "[t]his is a distinction [from Press I] without a difference," and that "[t]he $4.85 fee was clearly identified as a processing fee, not a commission or markup," Defs.' Reply at 16, Plaintiffs do not allege that Merrill Lynch misrepresented that no fee was being charged on the bonds. Rather, Plaintiffs specifically allege that Merrill Lynch misrepresented "that there was no markup charge nor any fee on the bonds that [Plaintiffs] purchased other than the relatively nominal fee which Merrill Lynch did disclose in the Processing Fee box." Second Amended Complaint, ¶ 29 (emphasis supplied). Therefore, a rational trier of fact could find that the confirmation statements deceived Plaintiffs into believing that Merrill Lynch's compensation was reflected in the processing fee, in violation of federal law, provided the other requirements of a Rule 10b-5 claim are met. See Chemical Bank, 726 F.2d at 943 ("The purpose of § 10(b) and Rule 10b-5 is to protect persons who are deceived in securities transactions — to make sure that buyers of securities get what they think they are getting. . . .).
Defendants assert that "a misrepresentation allegedly made in a confirmation slip or monthly statement received by Plaintiffs after they have already purchased the bonds does not meet the requirement for a Rule 10b-5 claim that the misrepresentation be in connection with the purchase or sale of any security." Defs.' Memo. at 26 n. 24 (internal citation omitted). MSRB Rule G-12, however, requires Merrill Lynch to send confirmations which contain "such other information as may be necessary to ensure that the parties agree to the details of the transaction." For the purpose of deciding the instant motion, the Court finds that these confirmation statements were made contemporaneously and in connection with the municipal bond transactions. See also In re JWP Securities Litig., 928 F. Supp. 1239, 1251 (S.D.N.Y. 1996) (discussing "in connection with" requirement and noting, inter alia, that the Second Circuit has "taken a broad view" of the requirement); In re Ames Dep't Stores, Inc. Stock Litig., 991 F.2d 953, 967 (2d Cir. 1993) ("[W]hen the fraud alleged is that the plaintiff bought or sold a security in reliance on misrepresentations as to its value . . . then whatever problems there may be with the case, a connection between the fraud and the transaction should not be one of them."). Plaintiffs, however, must still allege that they relied upon the misrepresentations allegedly contained in the confirmation slips.
Plaintiffs, however, have not adequately plead that they relied on the alleged misrepresentation. Although Plaintiffs assert that their "allegations of reliance are sufficient," Pl.'s Memo. at 47, they point to only one paragraph in the Second Amended Complaint that discusses reliance. See Second Amended Complaint, ¶ 55. This paragraph, beyond stating the barest conclusory allegation of reliance, asserts that Plaintiffs "are legally presumed to-have relied upon Merrill Lynch's compliance with the law, treatment of them in a manner consistent with applicable law, and correct representation of the true market price and compensation from the transactions." Id.
It is well-settled that where plaintiffs allege an affirmative misrepresentation, they must "demonstrate that [they] relied on the misrepresentation when entering the transaction." Burke v. Jacoby, 981 F.2d 1372, 1378 (2d Cir. 1992), cert. denied, 508 U.S. 909 (1993). This is in contrast to claims of fraudulent omissions, where "positive proof of reliance is not a prerequisite to recovery." Affiliated Ute Citizens v. United States, 406 U.S. 128, 153-54 (1972). Plaintiffs' failure to specify how they are legally presumed to have relied upon the alleged misrepresentation is particularly noteworthy in light of the fact that the Court, in Grandon I, expressly found that a presumption of reliance was warranted "[b]ecause no affirmative statements were made by Merrill Lynch[.]" Grandon I, 1997 WL 411924, at *5. Plaintiffs cannot now rely on that presumption for an entirely different claim and theory of liability, and they have otherwise failed to plead reliance in connection with the alleged misrepresentation claim with any particularity at all. Accordingly, the implied misrepresentation claim fails to state a claim upon which relief can be granted.
Plaintiffs also allege that Merrill Lynch failed to disclose that the markups that Merrill Lynch charged for the sales of municipal bonds were greater, than the fees which Merrill Lynch charged for similar equity transactions. See Second Amended Complaint, ¶ 62(3). This allegation also fails to state a claim upon which relief can be granted. It is well-settled that "[t]here can be no liability under the antifraud provisions of the securities laws absent a duty to disclose." Castillo, 1998 WL 342050 at *8 (citing Glazer v. Formica Corp., 964 F.2d 149, 156-57 (2d Cir. 1992)). "Omissions are only actionable where they cause the statements actually made to be misleading or if disclosure is required by a regulation or statute." Id. (internal citations omitted). Here, Plaintiffs have not supplied the Court with anything from which to conclude that Defendants have the duty to disclose to its municipal bond customers the fees charged on equity securities, nor have Plaintiffs specified how the failure to disclose this information made any statements to Plaintiffs misleading. Accordingly, and for the reasons set forth above, Defendants' motion to dismiss the Second Amended Complaint is granted as to the entire second cause of action.
This allegation is separate and distinct from the allegation of fraudulent undisclosed markups contained in the first cause of action. The differences between these allegations are manifest and may be determined by reference to the Court's discussion supra. Briefly, Plaintiffs' allegation of fraudulent undisclosed markups on the bonds is bolstered by a set of allegations which include reference to the industry standard for markups on similar-sized equity transactions, whereas the second cause of action alleges that Merrill Lynch's failure to disclosure the difference between equity and bond prices constitutes a stand-alone violation of the securities laws.
Plaintiffs' allegations regarding Merrill Lynch's fees on equity securities in the second cause of action blur into allegations contained in the first cause of action. See, e.g., Pl.'s Memo, at 43 (discussing second cause of action and stating, apparently in reference to allegations pertaining to the first cause of action, that "plaintiffs have pleaded in detail and with particularity that Merrill Lynch through specified officers at specified times and places knowingly and purposely engaged in the fraudulent practice and artifice of implementing a policy unlawfully to charge "significantly less' for municipal bonds than for equities of comparable dollar volume and size."). The Court finds that these allegations are preserved and subsumed by the allegations in the first cause of action, as indicated in the discussion supra. The Court finds, however, that by itself, the allegation of failure to disclose fees on equity securities to municipal bond customers does not state a cause of action.
IV. Statute of Limitations
It is well-settled that "[l]itigation instituted pursuant to Section 10(b) and Rule 10b-5 . . . must be commenced within one year after the discovery of the facts constituting the violation and within three years after such violation." Lampf, Pleva, Lipkind, Purvis Petigrow v. Gilbertson, 501 U.S. 350, 364 (1991). The statute of limitations commences "when the plaintiff obtains actual knowledge of the facts giving rise to the action or notice of the facts, which in the exercise of reasonable diligence, would have led to actual knowledge." Kahn v. Kohlberg, Kravis, Roberts Co., 970 F.2d 1030, 1042 (2d Cir.), cert.denied, 506 U.S. 986 (1992)). Thus, in order to be considered timely, a Rule 10b-5 complaint filed more than one year after the allegedly fraudulent behavior must state:
(1) the time and circumstances of the discovery of the fraudulent statement, (2) the reasons why it was not discovered earlier if more than one year has elapsed since the fraudulent conduct occurred, and (3) the diligent efforts which plaintiffs undertook in making or seeking such discovery.Boley v. Pineloch Assocs. Ltd., 700 F. Supp. 673, 676 (S.D.N Y 1988).
Defendants argue that "[t]hree of the four transactions that Plaintiffs challenge as fraudulent . . . were executed at prices and yields known to Plaintiffs more than a year before they alleged them in a complaint." Defs.' Memo, at 30-31. Plaintiffs, however, have alleged, inter alia, that (1) the bond market is opaque, meaning that there is no exchange providing real-time quoted prices to the retail public, Second Amended Complaint, ¶ 19; (2) that the fraudulent, excessive markups were undisclosed to investors, id., ¶ 28;, and (3) that "Plaintiffs first began to investigate Merrill Lynch's markups after the August 1995 monthly statement showing the unexpected and substantial decrease in [the] reported price of the Garden City bonds purchased only on August 25, 1995." Id., ¶ 56. Plaintiffs further allege that "[b]ecause interest rates had decreased since plaintiffs' purchase, and bond prices had thereby increased, the very anomalous price reported on that monthly statement constituted the first indication that Merrill Lynch's firm-wide practices reasonably bore investigating." Id.
Defendants raise no statute of limitations argument with respect to plaintiff Grandon's purchase of 45,000 Garden City bonds on August 25, 1995. Second Amended Complaint, ¶ 41.
The Court finds that the surviving claims of the Second Amended Complaint are timely. Plaintiffs have adequately alleged facts showing that a reasonable investor of ordinary intelligence would not have discovered the existence of the alleged fraud before August 31, 1995, the date Plaintiffs received the August confirmation statement. For the purposes of this motion, Plaintiffs have shown that their duty to inquire into the allegedly fraudulently excessive markups did not arise before August 31, 1995, because, inter alia, the municipal bond market is opaque, and the excessive fees were hidden. Therefore, the operative statute of limitations did not begin running until this date, and Plaintiffs' remaining claims are timely.
V. State Law Claims
Plaintiffs' third cause of action alleges claims arising under state law, namely claims for breach of contract and breach of fiduciary duty.See Second Amended Complaint, ¶¶ 64-68. Plaintiffs allege that the Court has supplemental jurisdiction over these claims, pursuant to 28 U.S.C. § 1367, because the claims are related to federal questions. See id., ¶ 1. Plaintiffs also assert that the Court has jurisdiction over these claims because of the parties' diverse citizenship. See id.
First, with respect to the breach of contract claim, "the plaintiffs must plead the existence of a contract between the parties, breach and damages." Pompano-Windy City Partners v. Bear, Stearns Co., 794 F. Supp. 1265, 1290 (S.D.N.Y. 1992). Plaintiffs have failed to do so. The Second Amended Complaint does not allege the existence of a contract between the parties, and Plaintiffs have apparently abandoned this claim, as their memorandum of law fails to address this conspicuous omission. Accordingly, Plaintiffs' breach of contract claim fails to state a claim upon which relief can be granted, and it is dismissed.
With respect to the breach of fiduciary duty claim, "[t]he fiduciary obligation that arises between a broker and a customer as a matter of New York common law is limited to matters relevant to affairs entrusted to the broker." Press II, 166 F.3d at 536 (quoting Rush v. Oppenheimer Co., 681 F. Supp. 1045, 1055 (S.D.N.Y. 1988)). Well-settled fiduciary duties arising from affairs entrusted to a broker-dealer include the duty to consummate a transaction, and the duty to use reasonable efforts to give customers information relevant to the affairs that have been entrusted to them. See id. The critical question before the Court, then, is whether the allegedly excessive markups on the bonds constitute "information relevant to the affairs that have been entrusted" to the Defendants. Id.
In Press II, the Court of Appeals, considering a similar claim, declined to hold that all markups must be disclosed in the course of a normal T-bill purchase on the grounds that "[s]o to hold would be to set a per se disclosure rule for markups on T-bills absent precedential justification." Press II, 166 F.3d at 537. This holding, however, was based at least in part on the finding that the amount of the markups in question fell "into a grey area of possible insignificance and possible significance." Id. at 535. Significantly, the alleged markups in Press II were low and deemed not excessive as a matter of law. See id. at 534-36.
The instant case differs from Press II in that Plaintiffs' have alleged, with the requisite particularity, a claim under federal law for fraudulent undisclosed markups. Given that the scope of Section 10(b) parallels the liability that exists pursuant to principles of common law fraud, see Chiarella v. United States, 445 U.S. 222, 227-28 (1980);United States v. Chestman, 947 F.2d 551, 560 (2d Cir. 1991), cert.denied, 503 U.S. 1004 (1992), the Court concludes that the amount of the alleged markups is "information relevant to the affairs that ha[d] been entrusted" to Merrill Lynch. Press II, 166 F.3d at 536. Accordingly, the Court finds that, under the circumstances and alleged particulars of this case, Plaintiffs have adequately stated a claim under New York law for breach of fiduciary duty. The Court therefore exercises supplemental jurisdiction over this claim.
CONCLUSION
For the reasons set forth above, Merrill Lynch's motion to dismiss the Second Amended Complaint, pursuant to Federal Rule of Civil Procedure 12(b)(6), is denied as to the first cause of action and the state law claim of breach of fiduciary duty in the third cause of. action, but granted as to the entire second cause of action and the breach of contract claim in the third cause of action. The parties are hereby directed to proceed with discovery, and to appear for a pre-trial conference on October 3, 2001, at 10:30 a.m. in Room 906, 40 Centre Street, New York, New York.
SO ORDERED.