Colonial Realty Corporation v. Bache & Co.

• Decision Date: 10 March 1966
• Docket Number: No. 144,Docket 29868.,144
• Citation: 358 F.2d 178
• Court: U.S. Court of Appeals — Second Circuit
• Parties: COLONIAL REALTY CORPORATION Plaintiff-Appellant, v. BACHE & CO., Defendant-Appellee.

358 F.2d 178 (1966)

COLONIAL REALTY CORPORATION Plaintiff-Appellant, v. BACHE & CO., Defendant-Appellee.

No. 144, Docket 29868.

United States Court of Appeals Second Circuit.

Argued November 8, 1965.

Decided March 10, 1966.

Spencer Pinkham, New York City (Colton & Pinkham, New York City), for plaintiff-appellant.

Marvin Schwartz (Sullivan & Cromwell, New York City, Peter R. Fisher, New York City, of counsel), for defendant-appellee.

Before LUMBARD, Chief Judge, and FRIENDLY and SMITH, Circuit Judges.

FRIENDLY, Circuit Judge:

Colonial Realty Corporation, a Delaware corporation with its principal place of business in Pennsylvania, brought this action in the District Court for the Southern District of New York against Bache & Co., a limited partnership organized pursuant to the New York Partnership Law and engaged in securities brokerage in New York City. The controversy arises out of Bache's sales of securities in Colonial's margin account during the stock market dip of May and June 1962. Bache claimed it acted under authority of a clause in its standard form of margin contract in which Colonial covenanted to "maintain such margins as you may from time to time require, upon my accounts, and promptly meet all margin calls." Colonial relied on an alleged oral agreement that Bache would not require a margin in excess of the minimum requirements of the New York Stock Exchange and also claimed negligence on Bache's part. With respect to all securities sold to meet calls exceeding the Stock Exchange's minimum, Colonial sought to recover the losses it had suffered, running into millions of dollars, and some $100,000 in commissions which Bache had collected.¹

The complaint predicated jurisdiction of the district court on both diversity and the existence of a federal question. Most of the claims were alleged to arise in the first instance from breach of contract or negligence, and in the second from Bache's failure to conduct its dealings in a manner "consistent with just and equitable principles of trade" within the meaning of §§ 6(b) and 15A(b) (7) of the Securities Exchange Act of 1934,² of Article XIV of the Constitution of the New York Stock Exchange (NYSE), and of Article I, § 2(a) of the By-Laws and Article III, § 1 of the Rules of Fair Practice of the National Association of Securities Dealers, Inc. (NASD). Bache moved for an order dismissing the complaint on the ground that it failed to state any federal claim and there was no diversity of citizenship, or, if that relief were denied, for an order compelling arbitration pursuant to its contract with Colonial and staying the action in the interim.

The district court dismissed the federal claims and, having found diversity, proceeded to hold a hearing to determine the applicability of the arbitration agreement.³ After the hearing, the judge issued a second order staying the action pending arbitration under the Federal Arbitration Act, 9 U.S.C. § 4, and New York CPLR § 7503; this included a provision amending the prior order which had struck the federal claims so as to grant Colonial leave to request an interlocutory appeal pursuant to 28 U.S.C. § 1292(b). Although the stay of what would have been an action at law was appealable under 28 U.S.C. § 1292(a) (1), Shanferoke Coal & Supply Corp. v. Westchester Service Corp., 293 U.S. 449, 55 S. Ct. 313, 79 L.Ed. 583 (1935), and Colonial's appeal therefrom necessarily involved the propriety of dismissal of the federal claims, see fn. 3, we granted leave under § 1292(b) to appeal from that ruling in order to eliminate any doubt as to our ability to reach an issue of general importance under the securities laws.

Colonial's assertion that the complaint alleged a violation of federally granted rights is based upon provisions in the Securities Exchange Act dealing with registration of exchanges and dealers' associations, and upon rules adopted pursuant to the statute by the NYSE and the NASD. Section 6(b) of the Securities Exchange Act provides:

"No registration shall be granted or remain in force unless the rules of the exchange include provision for the expulsion, suspension, or disciplining of a member for conduct or proceeding inconsistent with just and equitable principles of trade, and declare that the willful violation of any provisions of this chapter or any rule or regulation thereunder shall be considered conduct or proceeding inconsistent with just and equitable principles of trade."

Section 15A(b) (8) forbids registration of a national securities association unless:

"the rules of the association are designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to provide safeguards against unreasonable profits or unreasonable rates of commissions or other charges, and, in general, to protect investors and the public interest, * * *."

Under the NYSE Constitution, Art. XIV, § 6, disciplinary measures may be taken against a member found guilty "of conduct or proceeding inconsistent with just and equitable principles of trade"; the NASD By-Laws, Art. I, § 2(a), and Rules of Fair Practice, Art. III, § 1, prohibit membership by persons disciplined on this account and require members to "observe high standards of commercial honor and just and equitable principles of trade." The complaint alleged simply that Bache's dealings were not consistent with such principles without elaborating how, save insofar as this can be gleaned from the charges of breach of contract and of failure to use due care to protect its customer's interests.

Colonial relies largely on Baird v. Franklin, 141 F.2d 238 (2 Cir.), cert. denied, 323 U.S. 737, 65 S.Ct. 38, 89 L.Ed. 591 (1944), in which this court recognized that culpable failure by a stock exchange to enforce rules adopted pursuant to § 6(b) of the Securities Exchange Act may give rise to a federal claim against the exchange by an investor injured thereby. See Brown v. Bullock, 294 F.2d 415, 421 (2 Cir. 1961); Silver v. New York Stock Exchange, 302 F.2d 714, 719 (2 Cir. 1962), rev'd on other grounds, 373 U.S. 341, 83 S.Ct. 1246, 10 L.Ed.2d 389 (1963). Colonial urges that the civil liability thus implied from § 6(b) cannot reasonably be limited to an exchange but must extend to a member firm whose conduct has violated rules adopted by the exchange under the statute; it says that the delinquent broker in the Baird case would also have had to be held for an implied federal liability. Although we agree that a federal claim against the member firm existed in Baird since the misconduct charged was a violation of the statute itself, see 141 F.2d at 242, this does not establish that implication of a private right of action against an exchange for culpable failure to enforce its rules necessarily calls for recognizing a similar right against an individual broker who is claimed to have violated them.

We start from the proposition that the judicial recognition and enforcement of a private remedy not expressly afforded by the Securities Exchange Act is predicated on the duty of the courts "to make effective the congressional purpose" represented in "the statute and the federal policy which it has adopted." J. I. Case Co. v. Borak, 377 U.S. 426, 433, 84 S.Ct. 1555, 1560, 12 L.Ed.2d 423 (1964). Implication of a private right of action may be suggested by explicit statutory condemnation of certain conduct and a general grant of jurisdiction to enforce liabilities created by the statute, as in cases under §§ 10 and 14 of the Act, see Fischman v. Raytheon Mfg. Co., 188 F.2d 783 (2 Cir. 1951); J. I. Case Co. v. Borak, supra, or from such considerations as the protection intended by the legislature and the ineffectiveness of existing remedies, administrative and judicial, fully to achieve that end. See Baird v. Franklin, supra, 141 F.2d at 244-245; 2 Loss, Securities Regulation 945 (1961). Whether such a claim can be maintained for violation of stock exchange rules is a thorny problem because the effect and significance of particular rules may vary with the manner of their adoption and their relationship to provisions and purposes of the statute and SEC regulations thereunder; the difficulty lies in the scope of the unique statutory scheme of "supervised self-regulation" by exchanges and dealers' associations. See SEC, Report of Special Study of Securities Markets, H.R.Doc. No. 95, 88th Cong. 1st Sess., Pt. I, 3-4; Pt. 4, 692-728 (1963).

As to matters not covered by the statute or Commission regulations, the exchanges are given a wide range of discretion in establishing standards and principles that should govern trading of securities on the auction market; the mandate of § 6(b) that rules insure observance of "just and equitable principles of trade" could hardly be broader, the only specific requirement being that wilful violation of the statute be condemned. See Silver v. New York Stock Exchange, 373 U.S. 341, 352, 83 S.Ct. 1246, 10 L.Ed. 2d 389 (1963). That Congress did not intend violations of all rules adopted under § 6(b) to give rise to civil claims under federal law is somewhat indicated by the explicit reliance in the section on the disciplinary function of the exchanges to provide protection for the investing public, see Silver v. New York Stock Exchange, supra, 373 U.S. at 371, 83 S.Ct. 1246 (dissenting opinion). Basis for an even broader negation can arguably be found in the absence of any reference to exchange rules in the grant of federal jurisdiction over "all suits in equity and actions at law brought to enforce any liability or duty created by this chapter or the rules and regulations thereunder," Securities Exchange Act § 27, in contrast to the explicit reference to exchange rules in § 29(a) — although acceptance of this argument would not foreclose a contention that there might still be a federal claim of which district courts would have concurrent jurisdiction under 28 U.S.C. §§ 1331 or 1337. Compare T. B. Harms...