Fox Intern. Relations v. Fiserv Securities, Inc.

Citation: 490 F. Supp. 2d 590Docket: Civil Action Nos. 04-5877, 05-1559

Court: District Court, E.D. Pennsylvania; May 7, 2007; Federal District Court

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On September 18, 2003, Michael Kogan, an unlicensed securities broker, pleaded guilty to multiple counts of mail and wire fraud, resulting in an 87-month prison sentence and substantial restitution payments. Two lawsuits, Fox International Relations v. Fiserv Securities, Inc. and Sterin v. Fiserv Securities, Inc., have emerged from Kogan's fraudulent activities. Plaintiffs in these cases allege violations of the Securities Exchange Act of 1934, Rule 10b-5, the Pennsylvania Securities Act, common law fraud, breach of fiduciary duty, and negligent supervision. Four motions to dismiss filed by defendants Laucius and Fiserv are currently under consideration by the court. 

The factual background highlights that Fox International Relations, managed by Michael and Natan Lisitsa, invested funds through Kogan starting in 1996, unaware of his suspended brokerage license due to prior misconduct. After his suspension, Kogan continued to work at Penn Financial Group (PFG), where defendant Laucius served as president and majority shareholder. The allegations focus on the plaintiffs' investments and the defendants' roles in Kogan's fraudulent activities.

Defendant Fiserv, a registered broker/dealer, served as a clearing broker for PFG, managing brokerage accounts, executing trades, processing fund transfers, and sending account statements to PFG's clients. Plaintiffs, including Fox International Relations and the Sterin family, invested through PFG and Kogan, writing checks directly to Fiserv with the intention of maximizing investment profits. However, Kogan misappropriated the funds, transferring them to accounts he or his wife controlled, and altered plaintiffs' account addresses at Fiserv to obscure his actions. This led to plaintiffs receiving incorrect account statements, which were often returned as undelivered. Instead, Kogan provided false statements that misrepresented the status of their investments, which in many cases held little to no funds. An arrest warrant was issued for Kogan on February 11, 2003, related to these allegations, and PFG ceased operations in March 2003.

Defendant Laucius was aware of Kogan's suspended brokerage license and issues with account management, but still provided Kogan with access to Fiserv's software and allowed him to sign entries on Laucius' behalf. Laucius had knowledge of the misleading statements generated by Kogan and was involved in their creation and distribution. Furthermore, Laucius noted Kogan's receipt of large quantities of blank paper similar to that used by Fiserv, indicating potential misconduct.

Defendant Fiserv is accused of knowingly allowing Kogan, an unlicensed broker, unrestricted access to process daily trades, including control over passwords and security functions. This enabled Kogan to execute and clear securities transactions through Fiserv and PFG without proper authorization, despite Fiserv typically requiring a letter of authorization for such actions. Fiserv's oversight failures are highlighted by its lack of investigation into Kogan's numerous suspicious activities, including unauthorized account changes and fund transfers, along with its practice of allowing Kogan to reopen trading accounts after violations. 

In a separate section, the legal standard for a motion to dismiss under Federal Rule of Civil Procedure 12(b)(6) is outlined, emphasizing that well-pleaded facts must be accepted as true and viewed favorably toward plaintiffs. Claims can only be dismissed if no relief could be granted under any set of provable facts.

Currently, two motions to dismiss filed by defendant Laucius are being considered together due to their similarity. Laucius seeks dismissal of multiple claims, including violations of the Exchange Act and common law fraud. The court denies the motions concerning claims under Section 10(b) of the Exchange Act and Rule 10b-5, indicating that these claims will proceed.

Section 10(b) of the Exchange Act prohibits the use of manipulative or deceptive practices in the purchase or sale of securities, as outlined in 15 U.S.C. 78j(b). Rule 10b-5, established under this section, makes it unlawful to make untrue statements or omit material facts that would render statements misleading, per 17 C.F.R. 240.10b-5(b). Both provisions aim to promote full disclosure within the securities industry, as supported by case law such as Securities and Exchange Commission v. Zandford.

Investors harmed by false or misleading statements can pursue a private right of action under Section 10(b) and Rule 10b-5, which necessitates proving six elements: 1) a material misrepresentation or omission; 2) scienter (a wrongful state of mind); 3) connection to the purchase or sale of a security; 4) reliance; 5) economic loss; and 6) loss causation. Legal standards for these claims are further defined by the Private Securities Litigation Reform Act (the "Reform Act"), which imposes heightened pleading requirements. Specifically, plaintiffs must detail each misleading statement and the reasons for its misleading nature, as mandated by 15 U.S.C. 78u-4(b)(1).

Additionally, to establish scienter, plaintiffs must provide facts that create a strong inference of the defendant's required state of mind under 15 U.S.C. 78u-4(b)(2). Claims failing to meet these standards may be dismissed, as indicated in In re Alpharma Inc. Sec. Litig. Moreover, claims must also adhere to Federal Rule of Civil Procedure 9(b), which requires the plaintiff to provide comprehensive factual backgrounds related to the fraud, including specifics about the 'who, what, when, where, and how' of the events. Alternative methods of detailing the fraud's particulars may also fulfill this requirement, as noted in relevant case law.

Defendant Laucius' motions to dismiss regarding Section 10(b) and Rule 10b-5 claims focus on two primary arguments: (1) the plaintiffs fail to plead fraud "in connection with" securities transactions, and (2) they do not plead fraud with the required specificity under the Reform Act and Rule 9(b). The Court rejects these arguments, referencing the Supreme Court's ruling in Zandford, which established that fraud can be linked to securities transactions even without misrepresentation about security value. The Court finds sufficient allegations of fraud by the plaintiffs, including details of investments made through PFG and Kogan, Laucius' awareness of Kogan's suspended brokerage license, and Laucius' facilitation of Kogan's access to trading software. Furthermore, the Court determines that the plaintiffs adequately allege fraud with particularity, as their claims sufficiently inform Laucius of the misconduct alleged. As a result, Laucius' motions to dismiss are denied for both the Section 10(b) and Rule 10b-5 claims and for the claims under Section 20(a) of the Exchange Act.

Section 20(a) of the Exchange Act establishes joint and several liability for individuals who control violators of Section 10(b), requiring proof that the controlled party committed a primary violation and that the controlling individual was a culpable participant in the fraud. Defendant Laucius' motions to dismiss claims under Section 20(a) were denied because plaintiffs sufficiently alleged that defendant Kogan violated Section 10(b) and Rule 10b-5, meeting all necessary elements for a primary violation.

Additionally, Laucius' motions to dismiss claims under Sections 1-301, 1-306, 1-401, and 1-403 of the Pennsylvania Securities Act (PSA) were also denied. Section 1-301(b) prohibits employing unregistered agents, while Section 1-306 restricts employing individuals with suspended or revoked registrations without consent. Section 1-401 parallels Rule 10b-5, requiring similar proof elements, and Section 1-403 makes it unlawful for broker-dealers or agents to engage in manipulative or fraudulent securities transactions.

Defendant Laucius contends that plaintiffs do not possess a private right of action to enforce claims under specific sections of the PSA (1-301, 1-306, 1-401, and 1-403), citing Section 1-506, which restricts the ability to assert such rights unless explicitly provided in the act. The court disagrees, noting that while Sections 1-301, 1-306, 1-401, and 1-403 lack explicit causes of action, Sections 1-501 and 1-503 have been identified by courts as providing a private right of action for these claims. Specifically, Section 1-501 creates a limited cause of action for violations of the aforementioned sections but is deemed unavailable to plaintiffs in this case. Section 1-501 allows individuals to sue for damages if securities are sold in violation of certain provisions or regulations, including those related to Section 301. The Third Circuit has acknowledged that Section 1-501 offers a cause of action for violations of Sections 1-401 and 1-403 under certain conditions, and it also applies to Section 1-301. Additionally, Section 1-501 establishes a cause of action linked to violations of Section 1-306, despite its lack of explicit mention in the text.

Section 1-501 of the Pennsylvania Securities Act (PSA) limits the cause of action to those who either sell or purchase securities. In Biggans, the Third Circuit clarified that only defrauded sellers and buyers can sue the actual parties involved in the transaction, excluding claims against brokers who do not directly buy or sell the securities. Consequently, the plaintiffs cannot pursue a claim against Laucius under Section 1-501 since they have not alleged that he engaged in any securities transactions.

However, the court examined Section 1-503, which allows for liability against affiliates and individuals who materially aid in violations, regardless of whether they sold or purchased securities. While the Third Circuit has not previously addressed whether Section 1-503 applies to those not involved in the sale or purchase, it noted that prior cases suggest Section 1-501 is the exclusive source of civil liability for violations under certain sections of the PSA. 

The Pennsylvania Superior Court's decision in Brennan indicated that individuals who did not engage in securities transactions could still be liable under Section 1-503. Following this reasoning, the Third Circuit in McCarter reaffirmed that Section 1-503 could provide a cause of action against those who did not sell or purchase securities, aligning with the Brennan ruling. Thus, the court concludes that plaintiffs have a viable cause of action against Laucius under Section 1-503, despite their inability to do so under Section 1-501.

Under McCarter, the Court establishes that Section 1-503 allows for a cause of action against defendants who did not directly sell or purchase securities, contrary to the Third Circuit decisions in Biggans and Sharp. Various courts within this circuit have recognized that Section 1-503 permits lawsuits against broker-dealers, who are not liable under Section 1-501. Key cases supporting this interpretation include Jairett, which disagreed with the notion that Section 503 precludes private suits against brokers, and Carroll, which denied a motion for summary judgment on claims under Section 1-503.

The text of Section 1-503 explicitly states that various parties, including affiliates and broker-dealers who materially aid in a securities violation, are jointly and severally liable. This language differs from Section 1-501, which limits liability to those who offer, sell, or purchase securities. Despite some judicial debate suggesting that Section 1-503 only allows claims for parties already found liable under Section 1-501, the Court rejects this view, affirming that Section 1-503 creates a cause of action for those who materially assist in a violation, irrespective of prior liability determinations.

The Court finds that the plaintiffs have sufficiently alleged that defendant Laucius, as a principal executive officer and majority shareholder of PFG, materially aided Kogan in transactions violating the PSA. Specific allegations against Laucius include his role in employing Kogan, involvement in misleading statements regarding investment portfolios, and participation in drafting false communications. Consequently, the Court denies Laucius' motions to dismiss the claims brought against him under Sections 1-301, 1-306, 1-401, and 1-403.

Laucius' motions to dismiss the plaintiffs' claims under Section 1-501 of the Pennsylvania Securities Act (PSA) are granted. The plaintiffs in Claim 16 of the Third Amended Complaint and Claim 15 of the Second Amended Complaint allege violations of Section 1-501. The court finds that Section 1-501 allows a limited cause of action only against those who directly sell or purchase securities in violation of the PSA. Since Laucius did not engage in such transactions, the plaintiffs lack a private right of action against him under this section. Additionally, the court clarifies that the claims under Section 1-501 cannot be reinterpreted as claims under Section 1-503, which addresses secondary liability for those who materially aid in a violation of Section 1-501, as these sections represent distinct causes of action.

Conversely, Laucius' motions to dismiss the common law claims of fraud, misrepresentation, and breach of fiduciary duty in Claims 6 and 7 of the Third Amended Complaint and Claims 5 and 6 of the Second Amended Complaint are denied. Under Pennsylvania law, the elements required for common law fraud include a misrepresentation that is material, made with the intent to mislead, justifiable reliance by the victim, and resulting injury. The elements of fraudulent misrepresentation similarly demand a false statement intended to induce action, justifiable reliance, and resultant damage.

To establish a breach of fiduciary duty claim in Pennsylvania, plaintiffs must demonstrate a confidential relationship with the defendant, and that the defendant either negligently or intentionally failed to act in good faith for the plaintiff's exclusive benefit, resulting in injury to the plaintiff. Additionally, the defendant's failure to act solely for the plaintiff's benefit must be a significant factor in causing the plaintiff's injuries.

Defendant Laucius has moved to dismiss the plaintiffs' common law claims on two grounds: the lack of particularity in pleading fraud under the Reform Act and Rule 9(b), and the argument that the court should not exercise supplemental jurisdiction over these claims. The court finds that the plaintiffs have adequately pleaded fraud with particularity and decides to exercise supplemental jurisdiction, denying Laucius' motions to dismiss regarding these common law claims.

Defendant Fiserv has filed two motions to dismiss, which are addressed collectively, seeking dismissal of claims related to violations of the Exchange Act (Sections 10(b), 20(a), and 15(a)(1)), as well as violations of the Pennsylvania Securities Act (Sections 1-306 and 1-503), and common law claims of negligent supervision and breach of fiduciary duty. The court denies Fiserv's motions to dismiss the claims under Section 10(b) and Rule 10b-5, emphasizing that to succeed under these provisions, plaintiffs must prove a material misrepresentation or omission, scienter, connection to securities transactions, reliance, economic loss, and loss causation, while also adhering to heightened pleading standards.

The scienter requirement is critical in evaluating Fiserv's motions to dismiss in a securities fraud case. Under the Reform Act, plaintiffs must either demonstrate motive and opportunity for fraud or provide circumstantial evidence of reckless or conscious behavior. A reckless statement is defined as one that shows an extreme deviation from ordinary care, posing a significant risk of misleading investors. 

Fiserv's motions to dismiss assert three main points: (1) that plaintiffs fail to plead the purchase or sale of securities; (2) that they do not adequately plead scienter; and (3) that they lack particularity in their fraud allegations as mandated by the Reform Act and Rule 9(b). The Court finds that plaintiffs have sufficiently alleged the purchase or sale of securities, citing their investments through Kogan and PFG aimed at maximizing profit.

Regarding the scienter requirement, the Court agrees that plaintiffs provide sufficient circumstantial evidence of recklessness by Fiserv, including: (i) Fiserv's awareness of Kogan's unlicensed status; (ii) Fiserv's repeated closure of Kogan's trading accounts for violations, yet allowing him to reopen accounts; (iii) Fiserv permitting Kogan to trade without proper authorization; and (iv) Fiserv's failure to investigate various suspicious activities conducted by Kogan. Collectively, these allegations suggest that Fiserv's involvement exceeded mere bookkeeping, indicating a higher level of supervision and complicity in Kogan's operations.

Allegations against Fiserv indicate its awareness of Kogan's status as an unlicensed broker, contradicting standard practices for clearing brokers. The Court references past cases where claims under Rule 10b-5 were upheld despite the defendant's motions to dismiss. Plaintiffs provided sufficient detail to notify Fiserv of the alleged misconduct, including Fiserv shutting down Kogan's accounts for trading violations yet allowing him to open new ones without investigation into suspicious trading activities. The Court finds that the plaintiffs have not failed to state a claim, denying Fiserv’s motions to dismiss the claims under Section 10(b) and Rule 10b-5. 

Regarding Section 20(a) claims, the Court explains that to establish secondary liability, plaintiffs must demonstrate that Fiserv controlled Kogan and that Kogan committed a primary violation of securities laws. Fiserv contended that it was not a "controlling person," but the Court disagrees, emphasizing that clearing brokers are not typically seen as controlling persons of introducing brokers under federal securities law. Thus, the Court denies Fiserv's motions to dismiss the Section 20(a) claims as well.

The court granted motions to dismiss Section 20(a) claims against clearing brokers due to plaintiffs' failure to allege that these brokers had "actual control" over introducing brokers. However, the court found sufficient allegations that Fiserv is a "controlling person" of Kogan and PFG. Specifically, plaintiffs claimed Fiserv was aware that Kogan was unlicensed but allowed him to operate trading accounts, and despite shutting down Kogan's accounts for violations, permitted him to open new ones soon after. Regarding PFG, plaintiffs asserted that Fiserv had the power to influence the company's decision-making and control the dissemination of misleading statements.

Consequently, the court denied Fiserv's motions to dismiss the Section 20(a) claims. The issue will be revisited at the summary judgment stage. Conversely, Fiserv's motions to dismiss claims under Section 15(a)(1) of the Exchange Act were granted. Section 15(a)(1) prohibits unlicensed brokers from using interstate commerce to buy or sell securities unless registered. Fiserv argued that Section 15(a)(1) does not provide a private right of action, and the court concurred.

The Court has determined that Section 15(a)(1) of the Exchange Act does not provide a private right of action, aligning with the majority of judicial rulings on this matter. The analysis began with a review of the statute's text to assess whether Congress explicitly provided a right to sue. It concluded that Section 15(a)(1) lacks an explicit cause of action. The Court then examined Congress's intent regarding Section 15(a) by applying four factors from Cort v. Ash to evaluate if a private right of action should be implied. It found that the first two criteria—whether the plaintiff is among those for whom the statute was enacted and whether there is legislative intent to create or deny such a remedy—did not support implying a private right. Additionally, the legislative history was silent on the issue, and the presence of provisions within Section 15 for enforcement by the Securities Exchange Commission indicated that Congress did not intend to allow private actions against brokers or dealers for registration failures. Consequently, the Court concluded that implying a private right of action under Section 15(a)(1) would be inappropriate, resulting in the granting of defendant Fiserv's motions to dismiss the plaintiffs' claims.

Fiserv's motions to dismiss the plaintiffs' claims under Section 1-306 of the Pennsylvania Securities Act (PSA) are granted without prejudice, allowing for the possibility of an amended complaint. Plaintiffs' claims assert that Fiserv violated Section 1-306 by permitting Michael Kogan, an unlicensed broker-dealer, to trade securities. Fiserv contends that the plaintiffs lack a private right of action under Section 1-306 and that they have not sufficiently alleged that Fiserv "employed" Kogan. The court finds that while Section 1-503 provides a private right of action against a broker-dealer, the plaintiffs do not claim that Fiserv employed Kogan, only that it allowed him to trade. Consequently, the dismissal of the Section 1-306 claims is upheld.

In contrast, Fiserv's motions to dismiss the claims under Section 1-503 of the PSA are denied. These claims assert violations related to secondary liability under the PSA, which holds affiliates accountable for certain violations. The court maintains that the plaintiffs' claims under Section 1-503 are valid and should proceed.

Broker-dealers or agents who materially assist in a violation are jointly and severally liable unless they can prove they were unaware of the relevant facts. Fiserv's motions to dismiss claims under Section 1-503 of the PSA are denied because the plaintiffs have adequately alleged an underlying violation of Section 1-501 and have met the particularity requirements for fraud as mandated by the Reform Act and Rule 9(b). However, Fiserv's motions to dismiss the negligent supervision claims are granted. The court finds that the plaintiffs failed to establish that Fiserv had a duty to supervise Kogan or PFG, as they did not demonstrate an employment relationship or specify any applicable rules and regulations that would impose such a duty. As a result, the plaintiffs did not sufficiently notify Fiserv of the alleged misconduct. The dismissal of the negligent supervision claims is without prejudice, allowing plaintiffs the opportunity to amend their complaints if warranted.

Defendant Fiserv's motions to dismiss the plaintiffs' negligent supervision claims are granted, allowing plaintiffs the opportunity to amend their complaint if justified by the facts. Conversely, Fiserv's motions to dismiss the plaintiffs' breach of fiduciary duty claims are denied. Under Pennsylvania law, to establish a breach of fiduciary duty, a plaintiff must demonstrate the existence of a fiduciary relationship, which inspires confidence that the advisor will act in the client's best interest. This relationship requires the fiduciary to act in good faith and to inform the principal of relevant information. While a clearing broker typically does not owe fiduciary duties to customers of an introducing broker, plaintiffs allege that Fiserv was entrusted with control over their investment portfolios, thereby creating a fiduciary duty. The plaintiffs assert that Fiserv's actions, including the shutting down of accounts for violations and allowing an unlicensed broker to open new accounts, support their claims of breach of fiduciary duty.

Plaintiffs have alleged that defendant Fiserv owed them a fiduciary duty, leading the Court to deny Fiserv's motions to dismiss regarding claims of breach of fiduciary duties. This issue will be reconsidered at the summary judgment stage. The Court examined multiple motions to dismiss filed by defendants Eric Laucius and Fiserv Securities, Inc., granting some and denying others. Specifically, Laucius' motions are granted for claims under 70 P.S. 1-501, dismissing those claims with prejudice, but denied for all other claims. For Fiserv, the motions are granted regarding claims under Section 15(a)(1) of the Exchange Act, dismissing those claims with prejudice, and granted for claims under 70 P.S. 1-306, which are dismissed without prejudice, allowing plaintiffs to amend within twenty days if appropriate. An order will follow this ruling.

Defendant Fiserv's Motions to Dismiss are granted for plaintiffs' negligent supervision claims, specifically Claim 4 in both C.A. No. 04-5877 and C.A. No. 05-1559, which are dismissed without prejudice, allowing plaintiffs to amend their complaints within 20 days if the facts support such actions. All other aspects of Fiserv's Motions to Dismiss are denied. The court notes that it cannot consider documents outside the pleadings for dismissal motions, except for public records and prior judicial proceedings, which do not convert the motion into one for summary judgment. Fiserv included a "Clearing Agreement" in its motions, but the court will not take this document into account for the current ruling. Federal and Pennsylvania definitions of "broker," "dealer," and "broker-dealer" are outlined, emphasizing the roles in securities transactions. Additionally, it is noted that clearing firms handle back-office operations for brokerage firms. The plaintiffs, including Fox International Relations and individuals Lisitsa and Sterin, began investments through Kogan and Gersch from 1996 onward, receiving monthly statements related to those investments until early 2003. Kogan operated from an office in Jenkintown, Pennsylvania, directly across from PFG's office.

All individuals associated with PFG, specifically Eric Laucius and Michael Kogan, believed that Suites 621 and 633 operated as a single office. Fiserv provided Kogan with applications for plaintiffs to sign and brochures promoting Fiserv's services. In the case of Fox International Relations, plaintiffs allege that Laucius helped Kogan create a misleading internet site for account status, which did not accurately reflect investment values. Laucius was aware of trading violations associated with these accounts. Plaintiffs also contend that Fiserv had significant influence over PFG's decision-making, including the dissemination of false statements. The complaints label the enumerated counts as "Claims." According to Rule 9(b), fraud allegations must be stated with particularity, although state of mind can be generally averred; however, the Reform Act requires specific pleading of state of mind for claims under Section 10(b) and Rule 10b-5. Laucius further asserts that the plaintiffs failed to plead fraud with the required specificity, but the Court refutes this claim based on prior findings regarding the Section 10(b) allegations. The document references Pennsylvania securities laws, outlining unlawful acts related to securities fraud and broker-dealer conduct.

Plaintiffs' claims lack clarity regarding whether they assert fraudulent or negligent misrepresentation. Under Pennsylvania law, negligent misrepresentation requires proof of: 1) a misrepresentation of material fact; 2) made in circumstances where the misrepresenter should have known it was false; 3) with intent to induce reliance; and 4) resulting in injury to a party who justifiably relied on the misrepresentation. The analysis of both torts is treated similarly in this context. Additionally, defendant Fiserv's motion to dismiss plaintiff Natan Lisitsa for lack of standing is rejected. Fiserv contended that Lisitsa was not a purchaser or seller of securities, but the Court found that Lisitsa's actions—investing through PFG and Michael Kogan and writing checks to Fiserv for securities transactions—sufficiently support his standing. Consequently, the Court denies Fiserv's motion to dismiss in relation to Fox International Relations.