Stern v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 78-1377

• Decision Date: 16 July 1979
• Docket Number: No. 78-1377,78-1377
• Citation: 603 F.2d 1073
• Parties: Fed. Sec. L. Rep. P 96,931 Samuel STERN, Appellant, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., Appellee.
• Court: U.S. Court of Appeals — Fourth Circuit

Page 1073

603 F.2d 1073

Fed. Sec. L. Rep. P 96,931

Samuel STERN, Appellant, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., Appellee.

No. 78-1377.

United States Court of Appeals Fourth Circuit.

Argued Feb. 5, 1979.

Decided July 16, 1979.

Donovan M. Hamm, Jr., Baltimore, Md. (Peter H. Gunst, Frank, Bernstein, Conaway & Goldman, Baltimore, Md., on brief), for appellant.

David F. Albright, Baltimore, Md. (Richard M. Kremen, Christopher R. West, Semmes, Bowen & Semmes, Baltimore, Md., on brief), for appellee.

James H. Schropp, Asst. Gen. Counsel, Washington, D. C. (Harvey L. Pitt, Gen. Counsel, Paul Gonson, Associate Gen. Counsel, Theodore S. Bloch, Atty., Washington, D. C., on brief), for amicus curiae Securities and Exchange Commission.

Neal L. Petersen, Gen. Counsel, Laura M. Homer, Chief Atty., John J. Sullivan, Atty., Securities Regulation, Div. of Banking Supervision and Regulation, Washington, D. C., on brief, for amicus curiae The Bd. of Governors of the Federal Reserve System.

Before BUTZNER, RUSSELL and WIDENER, Circuit Judges.

DONALD RUSSELL, Circuit Judge:

This is a suit by a disappointed long-time speculator to recoup, under federal security laws, from his broker the losses sustained by him as a result of certain option purchases made entirely on the speculator's own independent responsibility against the positive advice of the broker's representative. The plaintiff-investor has stated in separate counts of his amended complaint a number of grounds for recovery, only one of which is pertinent to this appeal, I. e., the count stating an alleged implied right of action for a violation by the defendant-broker of Regulation T, ¹ in allegedly extending illegally credit for plaintiff's purchases. After joinder of issue and considerable discovery in the action, the defendant-broker moved for summary judgment on this count of the plaintiff's action. It supported the motion with an affidavit and with the discovery record. In a carefully reasoned opinion, the district judge concluded that no private claim for relief exists for violation of Section 7(c) and Regulation T and dismissed the count stating such claim, as set forth in plaintiff's amended complaint. On motion of the defendant, the district judge entered, pursuant to Rule 54(b), Fed.R.Civ.P., a final judgment granting summary judgment in favor of the defendant on the alleged action in this count. This appeal followed.

We affirm.

Section 7(c), the alleged violation of which provides the basis for the plaintiff's claim in the count under review, makes it unlawful for a broker, such as the defendant, to extend or maintain credit on any securities other than in conformity with the regulations issued by the Board of Governors of the Federal Reserve System. ² Pursuant to the authority given it by this section, the Federal Reserve Board issued Regulation T fixing the terms under which brokers may handle transactions under the statute. ³ Neither Section 7(c) nor Regulation T provides a private right of action for its violation. The plaintiff asserts, however, that the courts have recognized such right, employing at various times two rationales, the reliance on which "has caused," in the language of one commentator, "great difficulties." ⁴ The first basis for such an implied right of action was founded on the tort principle declared in § 286 of the Restatement of Torts (1934). ⁵ It is generally described as the statutory tort or Restatement rationale and had its genesis, so far as Section 7 is concerned, in Remar v. Clayton Securities Corporation (D.Mass.1949) 81 F.Supp. 1014.

In Remar, the Court, paraphrasing § 286 of the Restatement, declared "that where defendant's violation of a prohibitory statute has caused injury to the plaintiff the latter has a right of action If one of the purposes of the enactment was to protect individual interests like the plaintiff's." ⁶ It found that "the main purpose" of Section 7, was to regulate national credit policy and that any protection of the "small speculator" from individual loss by reason of its prohibition was merely a "by-product" of the statute's main purpose. ⁷ It grounded this finding on the statute's purpose on the House Report offered in explanation of the section, as drafted by the House Committee. Though Remar thus found that Congress had declared that the "small speculator's" protection was only a "byproduct" of the statute's "main purpose," such unintended but consequential "byproduct" result was sufficient in the Court's judgment to warrant the implication of a private right of action in favor of the "Small speculator " as an intended "subsidiary" beneficiary of the statute. ⁸ The Court recognized, however, that such action, being one in tort, would normally be subject to the traditional tort requirement of causation and to the accepted defense of contributory negligence or In pari delicto. ⁹ Since the case came before it on a motion for dismissal, the Court found it premature to consider at that stage the applicability of the causation requirement, saying that "(a) decision on this point should abide the taking of the testimony." ¹⁰ It did, however, deal with the possible defense of In pari delicto. It noted that the statute's prohibition ran Solely against the broker and then concluded that the defense of In pari delicto should not be available against the small and presumably unversed speculator because the statute, by directing its prohibition solely at the broker or lender assumed that the "small" borrower-investor was "incapable of protecting himself." ¹¹

This idea that the statute provided the "small speculator," with both a right of action and an immunity from the defense of In pari delicto, was upheld in later cases which adopted the statutory tort rationale. However, these cases generally emphasized that "recovery (in private cases under § 7) should be denied to the sophisticated trader on the ground that he (was) an accomplice in the violation" and because "(d)enying him a remedy would serve as a greater deterrent to future violations * * * than an allowance of relief." (Italics added) Comment, Securities Exchange Act of 1934 Civil Remedies Based Upon Illegal Extension of Credit in Violation of Regulation T, 61 Mich.L.Rev. 940 at 954 (1963); Margin Requirements, 66 Colum.L.Rev. at 1482-83; Note, Pearlstein v. Scudder & German: Implied Rights of Action for Violations of Federal Margin Requirements and the Demise of the In Pari Delicto Defense, 66 Nw.L.Rev. 372 at 376 (1972); Goldman v. Bank of Commonwealth (6th Cir. 1972) 467 F.2d 439, 446; Royal Air Properties, Inc. v. Smith (9th Cir. 1962) 312 F.2d 210, 213-14; Serzysko v. Chase Manhattan Bank (S.D.N.Y.1968) 290 F.Supp. 74, 88-90, Aff'd. 409 F.2d 1360 (1969), Cert. denied 396 U.S. 904, 90 S.Ct. 218, 24 L.Ed.2d 180; Moscarelli v. Stamm (E.D.N.Y.1968) 288 F.Supp. 453, 459. ¹²

Subsequent to Remar, a number of cases did deal with the causation issue which Remar had reserved for resolution at trial. In general, these cases followed the language of the commentator in Margin Requirements. In that article the author said that "(p)roof that the defendant's act 'caused' the plaintiff's loss is indisputably a prerequisite of recovery in tort (under Section 7)" and absent such proof, "recovery should be denied." ¹³ It has been stated that, in order to meet this burden, the plaintiff must show "that defendant's liberal offer of credit induced him to purchase stock (or options) which he would not have otherwise acquired." Landry v. Hemphill, Noyes & Co. (1st Cir. 1973) 473 F.2d 365, 370, Cert. denied 414 U.S. 1002, 94 S.Ct. 356, 38 L.Ed.2d 237 Reh. denied 415 U.S. 960, 94 S.Ct. 1492, 32 L.Ed.2d 576 (1974); Junger v. Hertz, Neumark & Warner (2d Cir. 1970) 426 F.2d 805 at 806, n. 1, Cert. denied 400 U.S. 880, 91 S.Ct. 125, 27 L.Ed.2d 118; Architectural League of New York v. Bartos (S.D.N.Y.1975) 404 F.Supp. 304, 315; See, also, Continental Grain, Etc. v. Pacific Oilseeds, Inc. (8th Cir. 1979) 592 F.2d 409, 412, n. 1. ¹⁴ In fact, it was argued in the first Pearlstein appeal, without apparent contradiction, that brokers had only been held liable theretofore under Section 7 where they had "Deliberately and wilfully induced the investor to buy securities on the assurance of an unlawful extension of credit." ¹⁵

Remar and its statutory tort theory of liability, with its causation requirement, remained the accepted basis for a private action under Section 7 until 1970. ¹⁶ In that year, the Second Circuit, drawing on the authority of J. I. Case Co. v. Borak (1964) 377 U.S. 426, 84 S.Ct. 1555, 12 L.Ed.2d 423, ¹⁷ enunciated as a second theory for recovery against the broker under 7(c) what is generally described as the "enforcement" or "social policy" basis for an implied right of action. ¹⁸ Under this "enforcement" theory, an action is to be implied in favor of the intended beneficiaries of a statute where necessary to implement the statute's underlying purpose. Applying that language to the Section 7 situation, the Court proceeded to find, on the basis of the same House Report on which Remar had relied, that, though the real purpose of Section 7 was "the protection of the overall economy from excessive speculation" and "the protection of individual investors was a purpose only incidental" to that primary purpose, that "incidental" purpose was sufficient to make the individual investors "intended beneficiaries" of the statute, properly entitled for that reason to invoke the statute as a predicate for a right of action in their favor. It, however, departed from the principle followed in the decisions which had adopted the Remar theory that any right of action under Section 7 should be reserved for the small, inexperienced investor. It declared flatly that the implied right of action under the statute was equally available to the experienced and knowledgeable trader as to the unsophisticated small speculator and that no amount of participation in...