Securities Investor Protection Corp. v. Vigman

• Decision Date: 07 November 1986
• Docket Number: No. 85-5786,85-5786
• Citation: 803 F.2d 1513
• Parties: , Fed. Sec. L. Rep. P 92,983 SECURITIES INVESTOR PROTECTION CORPORATION, Plaintiff-Appellant, v. Seymour VIGMAN, et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1513

803 F.2d 1513

55 USLW 2316, Fed. Sec. L. Rep. P 92,983

SECURITIES INVESTOR PROTECTION CORPORATION, Plaintiff-Appellant, v. Seymour VIGMAN, et al., Defendants-Appellees.

No. 85-5786.

United States Court of Appeals Ninth Circuit.

Argued and Submitted April 7, 1986.

Submission Withdrawn July 14, 1986.

Resubmitted Nov. 7, 1986.

Decided Nov. 7, 1986.

Roy G. Wuchitech, Sheppard, Mullin, Richter & Hampton, Los Angeles, Cal., for plaintiff-appellant.

David L. Ross, Greenberg, Traurig, Askew, Hoffman, Lipoff, Rosen & Quentel, P.A., Miami, Fla., for defendants-appellees.

Appeal from the United States District Court for the Central District of California.

Before WRIGHT, NELSON and KOZINSKI, Circuit Judges.

EUGENE A. WRIGHT, Circuit Judge:

Seventy-five defendants allegedly engaged in a fraudulent scheme of stock market manipulation that ultimately caused the failure of two securities brokerages and the loss of many of the brokerage customers' securities and cash. Appellant, Securities Investor Protection Corporation (SIPC), liquidated the brokerages and reimbursed their customers for the value of the cash and securities as of the liquidation.

SIPC sued the brokers and the third-party defendants as subrogee of the brokers' customers and in its own right. It alleged several theories of liability, one being securities fraud under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, 15 U.S.C. Secs. 78j(b) (1982); 17 C.F.R. Sec. 240.10b-5 (1984) (the Exchange Act claims). The court dismissed the Exchange Act claims on the ground that SIPC could not satisfy the purchase-or-sale requirement of an Exchange Act securities fraud claim.

PROCEDURAL BACKGROUND

In July 1981, SIPC instituted liquidation proceedings against two securities brokerages, First State Securities Corporation (FSSC) and Joseph Sebag Incorporated (Sebag) (collectively "the brokerages" or "the brokers"). SIPC brought suit in July 1983, after disbursing the brokerages' assets and reimbursing their customers for the difference between their statutory claims and the brokerage assets. The complaint alleged, among other claims, securities fraud in violation of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. See Securities Investor Protection Corporation v. Vigman, 764 F.2d 1309, 1312 (9th Cir.1985) (previous appeal of this case, reversing and remanding dismissal, based on personal jurisdiction and venue, of two defendants).

The district court consolidated Cain v. Vigman, No. CV-83-5674-AWT (C.D.Cal.) with SIPC's action. The Cain case is a class action by the brokerages' customers against the defendants. After allowing an amendment to SIPC's complaint, the district court orally granted the defendants' consolidated motion under Fed.R.Civ.P. 12(b)(6) to dismiss SIPC's Exchange Act claims, holding that SIPC lacked standing to assert those claims. The court reasoned that the Cain class would "be the more appropriate plaintiff." It entered final judgment on those claims under Fed.R.Civ.P. 54(b).

SIPC appealed. After we heard oral argument and submitted the appeal for decision, we withdrew submission to allow the parties to submit supplemental briefs on several questions that we propounded. The Securities Exchange Commission submitted an amicus brief, which we found helpful. We now order the appeal resubmitted for decision.

FACTS

SIPC alleges that, from 1964 through July 1981, the defendants engaged in a scheme to inflate the prices for the stocks of six companies. The scheme was carried out by cooperation among the defendants, who were officers and directors of the six companies and principals and employees of the brokerages.

SIPC alleges that the six companies' prospects were misrepresented through statements by company officials, press releases and financial statements. The illusion of active markets in the six stocks was allegedly maintained by misleading transactions in the defendants' accounts, in the brokerage proprietary accounts, and in accounts of unsuspecting customers.

When the scheme was uncovered, the prices of the six stocks fell drastically. Because the defendants had allegedly prostituted the brokerages by loading the proprietary accounts with the stock of the six companies, SIPC placed the brokerages under a protective decree in July 1981. In the process of liquidating the brokerages, SIPC allegedly had to disburse nearly $13 million to meet customers' claims for which the brokerages' assets were insufficient.

STANDARD OF REVIEW

This court reviews de novo a dismissal for failure to state a claim. Robertson v. Dean Witter Reynolds, Inc., 749 F.2d 530, 533 (9th Cir.1984). The dismissal will be affirmed only if it appears beyond doubt that under no set of facts could the plaintiff be entitled to relief. See Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 101-02, 2 L.Ed.2d 80 (1957); Simon Oil Co. v. Norman, 789 F.2d 780, 781 (9th Cir.1986).

ANALYSIS

A. Extent of SIPC Subrogation

In their briefs, the parties argued vigorously over the extent of SIPC's subrogation rights. At oral argument, they seemed to agree on this question. But we set forth briefly the law on this subject to avoid misunderstanding.

SIPC is a nonprofit corporation created by the Securities Investor Protection Act of 1970, as amended, 15 U.S.C. Secs. 78aaa-78lll (1982) (SIPA). It protects, from a broker's financial failure, the customers of securities brokers by insuring the net equity of customers' accounts up to specified maxima. See Touche Ross & Co. v. Redington, 442 U.S. 560, 564-65 n. 5, 99 S.Ct. 2479, 2483, 61 L.Ed.2d 82 (1979).

SIPC is obligated to insure only the value of brokerage customers' "net equity" as of the initiation of the liquidation proceedings. See 15 U.S.C. Secs. 78fff-3(a), 78lll (11) (1982). "Net equity" is a term defined in the Securities Investor Protection Act (SIPA). See 15 U.S.C. Sec. 78lll (11) (1982). It is the amount that the broker would have owed each customer had it liquidated all the customer's holdings on the date the SIPC filed for a protective decree, less any outstanding debt the customer owed to the broker. Id.

Under SIPA, a trustee may be appointed to return customer property, complete open transactions, enforce rights of subrogation and liquidate the business of the brokerage. 15 U.S.C. Secs. 78eee(b)(3), 78fff-1, 78fff-2; see SIPC v. Barbour, 421 U.S. 412, 417, 95 S.Ct. 1733, 1737, 44 L.Ed.2d 263 (1975). SIPC is required to advance the trustee necessary funds to complete open transactions and return customer property up to specified maxima. Barbour, 421 U.S. at 417, 95 S.Ct. at 1737; see also Touche Ross & Co. v. Redington, 442 U.S. 560, 564-65 n. 5, 99 S.Ct. 2479, 2483, 61 L.Ed.2d 82 (1979) (description of SIPC); SEC v. Securities Northwest, Inc., 573 F.2d 622, 624 (9th Cir.1978) (same). To the extent SIPC advances funds, either to the trustee or directly to brokerage customers, it is subrogated to customers' claims. 15 U.S.C. Secs. 78fff-3(a), 78fff-4(c). If customers could have recovered on an Exchange Act securities fraud claim for the monies advanced, then SIPC, as subrogee, could do so.

B. Securities Fraud Claims

The district court dismissed SIPC's Exchange Act claims because SIPC could not meet the purchase-or-sale requirement for standing to bring a private cause of action under Rule 10b-5.

SIPC asserts that the customers could have stated Exchange Act claims for the losses they would have suffered, had SIPC not reimbursed them. Instead of alleging specific purchases or sales that were tainted by the fraudulent scheme, however, SIPC contends that it may rely on any purchase or sale that was "touched" by fraud, Superintendent of Insurance v. Bankers Life and Casualty Co., 404 U.S. 6, 12-13, 92 S.Ct. 165, 168-69, 30 L.Ed.2d 128 (1971), to support its claims for the missing funds and securities. "The touch test, however, is nothing more than a restatement of the 'in connection with' test." In re Financial Corp. of America, 796 F.2d 1126, 1130 (9th Cir.1986).

1. Birnbaum Rule

In Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975), the Court adopted the Birnbaum rule, which requires a purchase or sale of a security for standing to sue on an implied cause of action under Section 10(b) of the Exchange Act and Rule 10b-5. See also Mosher v. Kane, 784 F.2d 1385, 1388 (9th Cir.1986). Under the Birnbaum rule, in order for SIPC to have stated an adequate subrogation claim, the fraud loss must be connected to the purchase or sale of a security before the customers were fully aware of the facts and before the deception had ended. See Shivers v. Amerco, 670 F.2d 826, 830 (9th Cir.1982) (citing Ohashi v. Verit Industries, 536 F.2d 849, 852-53 (9th Cir.), cert. denied, 429 U.S. 1004, 97 S.Ct. 538, 50 L.Ed.2d 616 (1976); and O'Brien v. Continental Illinois National Bank & Trust Co., 593 F.2d 54, 58 (7th Cir.1979)).

SIPC's argument, that it may rely on any sale or purchase made by customers during the time of the alleged fraudulent activity, does not persuade us. The fraud that it alleges must be causally related to the claims to which it is subrogated. See Hatrock v. Edward D. Jones & Co., 750 F.2d 767, 773 (9th Cir.1984). Furthermore, it is not enough to say merely that the fraud caused the liquidation of the brokerage firm. See In re Financial Corp. of America, 796 F.2d at 1130 (discussing the causation element of the "in connection with" requirement). The liquidation could have resulted in no subrogation at all had the customers' net equity claims been met by brokerage assets. ¹

SIPC contends that when it paid customers the value of missing securities, it constructively purchased them, and may now sue in its own right as purchaser. See Rich v. Touche Ross & Co., 415 F.Supp. 95, 99-100 (S.D.N.Y.1976) (holding that "SIPC liquidation qualifies as a sale" with respect to the customer, "where and to the extent customers' claims to specific shares...