Penn Mont Securities v. Frucher

Page 443

502 F.Supp.2d 443

PENN MONT SECURITIES and its partners, Plaintiffs, v. Meyer S. FRUCHER, et al., Defendants.

Civil Action No. 05-CV-6686.

United States District Court, E.D. Pennsylvania.

August 15, 2007.

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Lynanne B. Wescott, The Wescott Law Firm PC, Philadelphia, PA, for Plaintiffs.

Stephen J. Kastenberg, Paul Lantieri, III, Ballard Spahr Andrews & Ingersoll, Philadelphia, PA, for Defendants.

MEMORANDUM AND ORDER

ANITA B. BRODY, District Judge.

PennMont Securities ("PennMont") filed this putative class action against defendants Meyer "Sandy" Frucher, William N. Briggs, Norman Steisel, Kevin Michael Foley and Christopher Nagy ("defendants"), for violations of federal racketeering law and state tort law arising out of defendants' alleged mismanagement of the Philadelphia Stock Exchange ("PHLX" or "the Exchange") and demutualization of the Exchange in 2004.¹ Defendants were or are employees and/or officers of PHLX.

PennMont asserts eleven claims: (1) civil RICO; (2) RICO conspiracy; (3) breach of fiduciary duty ("direct claim"); (4) breach of fiduciary duty ("derivative claim"); (5) breach of contract; (6) conversion; (7) fraud; (8) fraudulent concealment; (9) negligence; (10) unjust enrichment; and (11) disgorgement. Before me is defendants' motion to dismiss.

Background

A. Overview

PennMont is a partnership based in Paoli, Pennsylvania and has been a member of PHLX since December 19, 1981. Compl., ¶ 1. PHLX is the oldest stock exchange in the country. Id., ¶ 7. From 1972 to 2004, PHLX operated as a non-profit mutual organization incorporated under Delaware state law. Id., ¶ 8. PHLX was comprised of 505 seats, of which Penn Mont owned approximately five. Id., ¶ 2. Seat holders were entitled to do business on the Exchange, and they also could earn revenue by renting or leasing their seats to others. Id., ¶ 27-28.

Prior to demutualization, PHLX's nonprofit status prohibited it from paying dividends or issuing stock. Id., ¶ 10. Members and seat holders paid fees to cover PHLX's operating costs. Id. at 11. Penn-Mont alleges that seat holders had a contractual relationship with the Exchange based on the PHLX Certificate of Incorporation, PHLX By-Laws, and the PHLX Code of Conduct. Id., ¶ 12.

Sandy Frucher became the Chief Executive Officer of PHLX and Chairman of the Board of Governors ("the Board") in 1997. Id., ¶ 14. Briggs has served as an employee and officer of PHLX for many years. Frucher hired Steisel as a consultant in 1999, and Steisel now is a "Senior Executive" of PHLX. Id., ¶ 16. Foley served as Chair of the Board's Demutualization Advisory Group. Id., ¶ 17. Nagy was Off Floor Vice Chairman and a member of the Board and the Demutualization Advisory Committee. Id., ¶ 18. Under Frucher's tenure, defendants allegedly engaged in continuous misconduct, which diminished the value of PHLX seats and harmed seat holders. Id., ¶ 4. Defendants' alleged misconduct culminated in demutualization in January 2004, which diluted Penn Mont's ownership interest in the Exchange, and enriched defendants and their allies.

B. Prior State Court Action

In 1998, PennMont and a member, Joseph Carapico, brought an action against PHLX and its directors in the Philadelphia County Court of Common Pleas for an injunction to prevent the sale of PHLX's assets to the American Stock Exchange. Def.'s Ex. D (State Action Compl.). The trial court denied the injunction, but the sale did not occur. In September, 2003, PennMont filed an amended complaint in the same action and against moved for an injunction, this time to prevent PHLX from undergoing demutualization. Def.'s Ex. E (First Am. Compl.). PennMont reiterated many of the same allegations it has asserted in the current federal action. On November 17, 2003, the Court of Common Pleas denied the preliminary injunction. Def.'s Ex. F (Ct.Com.Pl.order).

Defendants filed for summary judgment. Plaintiffs submitted a document entitled, "Findings of Fact and Conclusions of Law," in which they asserted new claims for money damages. On October 6, 2004, the Court of Common Pleas granted defendants' motion for summary judgment and dismissed plaintiffs' claims with prejudice. Def.'s Ex. L (Ct.Com.Pl.op.). The Court of Common Pleas ruled that PennMont had failed to timely contest the SEC's order approving rule-changes associated with demutualization. Id., p. 3. It further ruled that it had no authority to enjoin demutualization because, "Congress implicitly preempted this court from undermining the SEC's authority and from entering orders contrary to those of the SEC." Id., p. 4. The Court of Common Pleas also barred plaintiffs from prosecuting "new" claims for damages because (1) changing the direction of the litigation at that juncture would prejudice defendants; (2) plaintiffs' new claims "may" violate the statute of limitations; and (3) plaintiffs' new claims were derivative and sought damages, but that plaintiffs had not met the standing requirements to prosecute derivative claims. Id., p. 7.

Plaintiffs filed a motion for reconsideration, and leave to amend their complaint. Def.'s Ex. K (civil docket), p. 29, Ex. N (proposed Sec. Am. Compl.). The proposed second amended complaint asserted claims for breach of fiduciary duty, breach of contract, conversion, fraud, fraudulent concealment, negligence and unjust enrichment. On November 3, 2004, the Court of Common Pleas denied plaintiffs' motion for reconsideration and denied them leave to amend the complaint. Plaintiffs appealed to the Superior Court. On February 27, 2006, the Superior Court affirmed both the grant of summary judgment and the denial of leave to amend the complaint. Def.'s Ex. M, p. 7 (Super.Ct.op.). The Superior Court ruled that appellants had waived their right to contest demutualization because they never appealed the lower court's order denying the preliminary injunction, and they failed "to follow the protocol for challenging the SEC's ratification of the [demutualization] plan." Id., p. 7.

The Superior Court further ruled: "Appellants' inaction with regard to the lower court's denial of their request for injunctive relief resulted in preemption of this matter by the SEC." Id., pp. 6-7. Having "acquiesced" to the lower court's judgment, appellants could not press their claims, whether at law or at equity. Id., p. The Superior Court also affirmed the lower court's denial of leave to amend. The Superior Court ruled that leave to amend should be liberally granted, but not "`where it will present an entirely new cause of action or unfairly surprise or prejudice the opposing party.'" Id., p. 5 (citations omitted). Leave to amend also should not be granted, the Superior Court reasoned, if the party seeking leave "`will be unable to state a claim on which relief could be granted.'" Id. The Superior Court further ruled that, "Appellants' argument founders on their inability, even with amendments, to state an actionable claim." Id. Appellants were unable to state a claim because appellants had acquiesced to demutualization, and their causes of action, "past, present, and proposed, emerge[d] either directly or indirectly out of their opposition to demutualization ...." Id., p. 5. As a result, the Superior Court affirmed the lower court.

C. Federal Complaint

In 2005, Penn Mont filed a federal complaint in this case purportedly on behalf of itself, all shareholders of PHLX, and also on behalf of PHLX. The complaint asserts the same state law claims presented in the proposed state court second amended complaint, in addition to claims under civil RICO. 18 U.S.C. ¶ 1964(c); compare Def.'s Ex. N, ¶¶ 151-199, with Compl., ¶¶ 75-255.

Mismanagement of Subsidiaries

The earliest allegations of misconduct in the federal complaint relate to PHLX's decision to grant generous severance packages to former officers accused of wrongdoing. Former PHLX officers — not named as defendants in this action — allegedly mismanaged PHLX's two subsidiaries, the Philadelphia Depository Trust Company ("Philadep"), and a clearing corporation, Stock Clearing Corporation of Philadelphia ("SCCP"). Timothy J. Guiheen, former president of Philadep and SCCP, and Nicholas Giordano, former president and CEO of PHLX, allegedly transferred funds from Philadep's and SCCP's general corporate funds to PHLX to cover PHLX's "short-term cash deficits." Compl., ¶ 71. Mingling the subsidiaries' revenues with PHLX's general funds allegedly violated federal law, and Guiheen and Giordano's misconduct led to regulatory investigations by the Securities and Exchange Commission and the Department of Justice. At Frucher's direction, unspecified persons nonetheless offered "golden parachutes" to both Guiheen and Giordano. Id., ¶¶ 75, 79. PHLX also "bought out" a real estate lease for $1,000,000 because the SEC required PHLX to dissolve Philadep and restrict operations of SCCP. Id., ¶ 129

Conflicts of Interest and Corporate Waste

According to PennMont, under Frucher's tenure, conflicts of interest and selfdealing abounded. Frucher "controlled" the Nominating Committee, which was responsible for recommending appointments to the Compensation Committee. Id., ¶ 91. PHLX paid Board members handsomely for participating in meetings, and Frucher made Board members beholden to him by raising their stipends for serving on the Compensation Committee. Id., ¶ 95. Frucher and the Board also extended the length of permissible terms of service so Board members could collect fees and expenses from PHLX for a longer period of time. Id. ¶94.

As Penn Mont tells it, defendants approved excessive compensation for themselves and the Board, including bonuses and severance packages for their friends, which depleted PHLX's dwindling assets. Penn Mont alleges that Frucher violated his duties as an officer and board member by advocating such excessive payments. Id., ¶ 92. In 1999, Frucher hired his friend, defendant Steisel, to serve...