429 F.2d 1136 (2nd Cir. 1970), 92, Pearlstein v. Scudder and German
|Docket Nº:||92, 33315.|
|Citation:||429 F.2d 1136|
|Party Name:||Stanley S. PEARLSTEIN, Plaintiff-Appellant, v. SCUDDER & GERMAN, a Partnership, Defendant-Appellee.|
|Case Date:||July 02, 1970|
|Court:||United States Courts of Appeals, Court of Appeals for the Second Circuit|
Argued Nov. 5, 1969.
Joseph Tiefenbrun, Henry Conan Caron, New York City, of counsel, for appellant.
Myron S. Isaacs, Hellerstein, Rosier & Rembar, New York City, for appellee.
Before WATERMAN, FRIENDLY and SMITH, Circuit Judges.
WATERMAN, Circuit Judge:
Appellant Stanley S. Pearlstein, the plaintiff below, sued Scudder & German, a partnership engaged in the securities business, for damages which he alleged he suffered because the defendant had violated the margin and antifraud provisions of the federal securities laws. 1 Plaintiff's allegations grew out of two
distinct purchases of bonds he bought through the defendant, who acted as his broker. Although these transactions overlapped in time they can best be described separately. The first of these, which can be termed the 'Lionel transaction,' began on March 6, 1961, when plaintiff bought fifty convertible bonds of the Lionel Corporation for a total price of $59,625.41 despite defendant's advice against the purchase. Plaintiff financed this purchase partly through a bank loan of $48,000 arranged by the defendant against the bonds and partly through a payment to defendant of $4,598.53 in cash. These two payments fell short of the purchase price by $7,026.88, however, and plaintiff continued to owe this balance to the defendant. Under Federal Reserve System Regulations 2 the payment of this sum was due on March 15, 1961, seven business days after the date of purchase. Plaintiff did not pay any portion of this balance by that day. As payment had been delayed beyond the permissible time, defendant was obligated by law to sell the bonds on plaintiff's account. However, defendant made no such sale but, instead, on April 5, transferred the bonds to the lending bank as security for its loan and did not even demand of the plaintiff payment of the balance due until June 8. Finally, on August 7, plaintiff was served with a summons in a suit instituted by defendant to collect this sum.
At about this time plaintiff must have developed serious doubts as to the legality of his debt to defendant, both in this transaction and in that described below. He consulted a lawyer concerning the matter, and on August 8 he visited the Securities and Exchange Commission, the New York Stock Exchange, and the National Association of Security Dealers. He was everywhere told that his obligation was valid. The following day, August 9, plaintiff entered into a stipulation of settlement in the suit defendant had commenced, promising to pay the sum he owed in two installments on August 11 and September 20, 1961. Plaintiff made both payments on schedule. The bank which held the bonds as security for its loan to plaintiff eventually sold them in three lots on May 11 and May 18, 1962, and April 19, 1963, for a total price of $33,159.14. Thus Pearlstein suffered a total loss of $26,466.27 on his purchase of Lionel bonds.
The second or 'AMF' transaction germane to this lawsuit involves the purchase by plaintiff, on a 'when issued' basis, of 100 convertible bonds of the American Machine and Foundry Company ('AMF'). Once again plaintiff made the purchase contrary to defendant's advice, at a total price of $150,082.64. Defendant had a short position in these bonds and told plaintiff that it could furnish him his bonds upon their issuance by AMF in the near future from this short position. Plaintiff agreed. The bonds became available for purchase on March 23, 1961 and payment under Regulation T should have been made April 4. Although payment was not made by that date defendant did not demand payment of any part of the total sales price until May 22, 1961. After various subsequent requests for payment were ineffectual defendant threatened plaintiff with legal action in August. On August 9, 1961, the same day that Pearlstein entered into the stipulation of settlement respecting the Lionel bonds, the parties entered into an agreement with regard to the AMF bonds as well. The agreement provided that defendant would attempt to arrange
a bank loan of $100,000 secured by the bonds, and Pearlstein would pay the defendant the additional $50,000 himself in two equal installments on August 11 and November 8, 1961. The bank loan was accordingly arranged for and Pearlstein made the first payment of $25,000 on August 11 as scheduled. However, he was unable to meet the November 8 payment and he obtained an extension from defendant until February 8, 1962. In return for this extension plaintiff signed a confession of judgment in a suit the defendant had commenced against him that same day. This document provided that defendant could obtain a judgment against plaintiff for the debt owed without further notice to him. Plaintiff failed to make payment on February 8, 1962, and, pursuant to the confession, judgment was accordingly entered against him in the Supreme Court of New York for $22,712.81, a sum reflecting adjustments for several payments made by plaintiff on the one hand and for interest and costs accruing to defendant on the other. Eventually the lending bank sold the AMF bonds on May 29, 1962, at a price which caused plaintiff to suffer a total loss of $59,000 on the AMF transaction.
After he had begun the present lawsuit in the federal court below plaintiff sought to reopen the New York judgment of $22,712.81 which defendant had obtained. The New York judge, Hecht, J., dismissed his motion, suggesting that plaintiff's remedy, if any, lay in the federal courts. Pearlstein did not appeal.
Plaintiff was hospitalized for surgery on two occasions during these transactions. The lower court found, however, that plaintiff's ill health did not affect his capacity to understand and evaluate his business dealings.
In the instant case Pearlstein sought to recover from defendant the difference between the amounts he would have received for the Lionel and AMF bonds if defendant had sold them on his account on the day payment was due and the amounts actually received when the banks sold the bonds much later. In seeking these damages plaintiff alleged not only that defendant had violated the securities laws, but also that it had committed fraud. The court below held that plaintiff had standing to sue for damages under Section 7(c) of the Securities Exchange Act of 1934 and that defendant had violated both this section and Regulation T of the Federal Reserve System. However, the court also held that plaintiff was bound by the stipulations of settlement he had entered into with defendant in both transactions and that the judgment entered in the AMF transaction amounted to res judicata. The court also held that plaintiff had not been treated fraudulently.
We agree with the district judge below that defendant violated the federal securities laws by extending credit to the plaintiff and that Pearlstein has a right of action against the defendant. We disagree, however, with the holding that the stipulations of settlement and the New York judgment in the AMF transaction bar this suit. Accordingly, we reverse and remand for further proceedings consistent with the approach taken in this opinion.
At the outset we express reservations as to the legality of the size of the loans, up to two thirds of the value of the bonds, which defendant procured for plaintiff-- a matter quite distinct from the length of time defendant extended credit to plaintiff. It appears from our own examination of the relevant law 3 that in 1961 a broker could not legitimately arrange a loan for the purchase of securities, secured by those same securities, for more than 30% Of their value. The parties have not raised this issue, however, and for that reason we do not deal with it except to call the matter to the attention of the parties and of the district court on remand.
In regard to Regulation T, upon which the plaintiff bases this suit, it seems reasonably clear that defendant
violated federal law when it failed in each instance to sell the bonds after seven business days had expired without payment. No reason appears why such a sale could not easily have been accomplished in the case of the AMF bonds, either by repurchase on the part of the defendant, who had sold plaintiff the bonds from its own short position, or by resale to third parties. The Lionel bonds present a somewhat more difficult problem, in that a loan secured by the bonds had been arranged by the defendant at the outset of the transaction, and defendant was under an obligation to transfer the bonds to the bank when the loan was executed. The record does not divulge whether title to the securities was also to pass to the bank at the time the loan was made. However, in any event, it appears that whereas payment on the bonds was due from plaintiff on March 15, 1961, defendant did not deliver the bonds to the bank or receive the proceeds of the loan from the bank until April 5. At the time payment was due, therefore, any contract of the plaintiff with the bank was still executory, and it lay within the power of defendant to refuse delivery of the bonds, thus cancelling the loan agreement and creating in its place a liability in Pearlstein for whatever portion of the bank's expected interest the bank might require in damages. 4 Brokers have been held in violation of the margin requirements when they arranged illegal bank loans as well as when they extended credit themselves, 5 and we think an equal duty exists to take reasonable steps to prevent (at no risk to the broker) the execution of a transaction which has become illegal subsequent to the arrangement of a loan to...
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