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Frederick v. Smith

November 9, 2010

LEONARD L. FREDERICK, THE ESTATE OF COLETTE A. FREDERICK, FRANCES A. FREDERICK, MATTHEW F. STREIB, LAUREN A. STREIB, JOHN SASSER, III, SUSAN SASSER, RICHARD J. LISCO, DARIA H. LISCO, ANTHONY MEOLA AND MARIA MEOLA, PLAINTIFFS-APPELLANTS,
v.
MAXWELL BALDWIN SMITH, HOLLY SMITH, CANTONE RESEARCH, INC., PNC INVESTMENTS, J.J.B. HILLIARD, W.L. LYONS, INC., ATLANTIC GROUP SECURITIES, INC., AND RICKEL & ASSOCIATES, INC., DEFENDANTS, AND MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., DEFENDANT-RESPONDENT.



On appeal from the Superior Court of New Jersey, Law Division, Morris County, Docket No. L-1108-09.

The opinion of the court was delivered by: Fisher, J.A.D.

NOT FOR PUBLICATION WITHOUT THE APPROVAL OF THE APPELLATE DIVISION

APPROVED FOR PUBLICATION

Submitted October 27, 2010

Before Judges Cuff, Fisher and Simonelli.

Plaintiffs commenced these actions*fn1 alleging that defendant Maxwell Baldwin Smith (Smith) convinced them to invest in Healthcare Financial Partnership (HFP), a fictitious entity. As part of the fraud, Smith instructed plaintiffs to convey the invested funds to an account he maintained with defendant Merrill Lynch, Pierce, Fenner & Smith (Merrill Lynch). Because plaintiffs had no relationship with Merrill Lynch, and because Smith had no relationship with Merrill Lynch other than as owner of the account into which the funds were placed, we conclude that, as a matter of law, no duty should be imposed on Merrill Lynch to periodically examine the account's activities for indicia of fraud and, therefore, affirm the order dismissing the claim.

In April and June of 2009, these four separate actions were filed against Smith, his wife Holly Smith, and several investment advisor firms, alleging Smith created and orchestrated a scheme to defraud them. After the actions were consolidated, Merrill Lynch moved for dismissal pursuant to Rule 4:6-2(e). Plaintiffs opposed the motion and cross-moved for an order compelling arbitration. Merrill Lynch's motion was granted and plaintiffs' cross-motion was denied on October 23, 2009. When the remaining issues in these actions were later resolved, plaintiffs filed this appeal, seeking our review of the order dismissing the negligence claims asserted against Merrill Lynch and the order denying plaintiffs' motion to compel arbitration.

A complaint should be dismissed for failure to state a claim pursuant to Rule 4:6-2(e) only if "the factual allegations are palpably insufficient to support a claim upon which relief can be granted." Rieder v. State Dep't of Transp., 221 N.J. Super. 547, 552 (App. Div. 1987). This standard requires that "the pleading be searched in depth and with liberality to determine whether a cause of action can be gleaned even from an obscure statement." Seidenberg v. Summit Bank, 348 N.J. Super. 243, 250 (App. Div. 2002) (citing Printing Mart-Morristown v. Sharp Elecs. Corp., 116 N.J. 739, 746 (1989)). The pleader is entitled to "the most favorable inferences which may be reasonably drawn from" the pleading's allegations, Rappaport v. Nichols, 31 N.J. 188, 193 (1959), and, in reviewing a Rule 4:6-2(e) dismissal, we apply the same standard, Seidenberg, supra, 348 N.J. Super. at 250; Donato v. Moldow, 374 N.J. Super. 475, 483 (App. Div. 2005).

As part of their negligence claims, plaintiffs alleged that Smith convinced them to invest in HFP, which he claimed was "a secure tax-free investment which paid a high level of interest through investment in a diversified portfolio of high yielding income projects." According to their complaints, plaintiffs collectively invested approximately $10 million in HCP over a number of years. Smith obtained these funds by instructing plaintiffs to make their checks payable to "Merrill Lynch A/C #36641" or "directly to Merrill Lynch," misrepresenting to plaintiffs that Merrill Lynch was the security's underwriter. According to plaintiffs, the referenced account was a personal account Smith opened at Merrill Lynch "for the sole purpose of furthering the Ponzi scheme." Once plaintiffs' checks were deposited in Smith's personal Merrill Lynch account, Smith remitted to plaintiffs phony correspondence memorializing the deposit and then used the funds for his own benefit. By the time plaintiffs discovered what was happening, they had lost nearly their entire investments.

The complaints alleged that while Smith was orchestrating his fraud, he was employed by: defendant Hilliard W.L. Lyons, Inc., from 1999-2003; defendant PNC Investments from 2004-2005; and defendant Cantone Research, Inc., from 2005-2009. Plaintiffs do not allege Smith was ever employed by Merrill Lynch. Notwithstanding the lack of any relationship between Merrill Lynch and Smith or the lack of any relationship between plaintiffs and Merrill Lynch, plaintiffs alleged Merrill Lynch was negligent for failing to discover Smith's use of his Merrill Lynch account to perpetrate a fraud.*fn2 Plaintiffs acknowledged that ordinarily a bank only owes duties to its customers, but claimed that a fiduciary relationship was established in this case because they wrote checks directly to Merrill Lynch when investing in HCP.

Although Judge W. Hunt Dumont mentioned that plaintiffs' claims "[did] have a certain superficial appeal,"*fn3 he interpreted the applicable law as limiting a brokerage firm's duty to only its customers and dismissed the negligence claims asserted by plaintiffs against Merrill Lynch. In appealing, plaintiffs argue that although a bank or brokerage firm does not typically owe a duty to non-customers, Merrill Lynch owed them a duty in this case because it "accepted more than $9 million of [p]laintiff[s'] money . . . by way of checks payable to Merrill Lynch."

Whether a duty should be imposed is a matter of law, Kernan v. One Washington Park Urban Renewal Associates, 154 N.J. 437, 445 (1998); Arvanitis v. Hios, 307 N.J. Super. 577, 581 (App. Div. 1998), that poses "'a question of fairness'" involving "'a weighing of the relationship of the parties, the nature of the risk, and the public interest in the proposed solution,'" Kelly v. Gwinnell, 96 N.J. 538, 544 (1984) (quoting Goldberg v. Hous. Auth. of Newark, 38 N.J. 578, 583 (1962)). In reviewing a trial judge's determination that a duty does or does not arise in a particular situation, we are bound neither by the trial judge's interpretation of the law nor the judge's view of the legal consequences of the alleged facts. Manalapan Realty, L.P. v. Twp. Comm. of Manalapan, 140 N.J. 366, 378 (1995).

Although our courts have not previously considered whether a brokerage firm owes a duty towards non-customers in this context, our Supreme Court has expressed a "reluctance to impose a duty of care on banks in respect of a total stranger." Brunson v. Affinity Fed. Credit Union, 199 N.J. 381, 403 (2009); see also City Check Cashing v. Mfrs. Hanover Trust Co., 166 N.J. 49, 60 (2001).

The Court's decision in City Check Cashing is particularly instructive. There, a check cashing business was presented with a forged check appearing to have been marked certified by the defendant bank. Id. at 52-53. Before cashing the check, the manager contacted a bank representative who initially expressed concerns about the check's legitimacy and promised to look at it more closely. Id. at 53-54. Not hearing from the bank representative for several hours, the store manager cashed the check. Id. at 55. In finding no maintainable negligence claim against the bank, the Court held that "[a]bsent a special relationship, courts will typically bar claims of non-customers against banks." Id. at 60. That is, the Court held that absent some "agreement, undertaking or contract" between the parties, a bank does not owe a duty to a non-customer, id. at 62, explaining that "[i]n actions based on nonfeasance," there must be "some definite relation between the parties, of such a character that social policy justifies the ...


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