SECURITIES & EXCHANGE COM'N v. Packer, Wilbur & Co., Inc.

Citation362 F. Supp. 510
Decision Date28 June 1973
Docket NumberNo. 71 Civ. 1385.,71 Civ. 1385.
PartiesSECURITIES AND EXCHANGE COMMISSION, Plaintiff, Securities Investor Protection Corporation, Applicant, v. PACKER, WILBUR & CO., INC., et al., Defendants.
CourtUnited States District Courts. 2nd Circuit. United States District Courts. 2nd Circuit. Southern District of New York

Gold, Farrell & Marks, New York City, for Trustee; Martin R. Gold, New York City, of counsel.

Shearman & Sterling, New York City, for Coggeshall & Hicks, Inc.

Feldesman & D'Atri, New York City, for Effrem Arenstein.

Theodore H. Focht, Washington, D. C., for Securities Investor Protection Corp., Michael E. Don, Washington, D. C., of counsel.

OPINION

COOPER, District Judge.

I. INTRODUCTION

We are asked to deny to a registered broker-dealer and to an active securities trader, each claiming financial losses resulting from a stock transaction between them, the legal right to reimbursement out of the funds administered by the Securities Investor Protection Corporation (SIPC) as provided by the Securities Investor Protection Act of 1970 (15 U. S.C. § 78aaa-78iii). The application before us is by the Trustee of Packer Wilbur & Co., Inc. (Packer Wilbur); the active securities trader is Effram Arenstein (Arenstein); Coggeshall & Hicks, Inc. (Coggeshall), the registered broker-dealer. The application has legal merit; we uphold it.

The claims herein arise from the same transaction. On February 3, 1971, Arenstein, a customer of both Coggeshall and Packer Wilbur, instructed Coggeshall to purchase two thousand (2,000) shares of Syntex common stock. The purchase was effected at a net price of $90,933.82, settlement date February 10. Arenstein did not have sufficient funds in his Coggeshall account to cover the cost of the securities.

Three days prior to settlement date, February 8, 1971, Arenstein instructed Coggeshall to deliver 2,000 shares of Syntex against payment to Packer Wilbur. Coggeshall delivered the shares, receiving from Packer Wilbur two checks payable to its order aggregating $90,933.82. The checks were dishonored upon presentment to the bank because of insufficient funds. To date they have not been paid. (See Trustee's Memorandum of November 22, 1972, p. 2.)

On the same date (February 8), Arenstein instructed Packer Wilbur to sell 2,000 shares of Syntex. At that time Arenstein did not have any Syntex stock in his Packer Wilbur account and did not own any. (See Trustee's Memorandum, supra at p. 2.) Packer Wilbur, having obtained possession of the 2,000 shares of stock, resold the same for $94,101.71.

Coggeshall commenced an action against Packer Wilbur for the amount due on the dishonored checks. This action was stayed by order of this Court upon appointment of the Trustee as Receiver for Packer Wilbur on June 21, 1971. Thereupon Arenstein and Coggeshall filed their respective claims which we now dispose of.1

II. THE ACT

The Securities Investor Protection Act of 1970 was enacted to stem the growing loss of confidence of public investors in the ability of the brokerage industry to protect customer accounts and generally strengthen the financial responsibility of broker-dealers so as to thereby eliminate, to the maximum extent possible, risks which lead to customer loss. Moreover, the Act seeks to insulate the securities market from any domino effect which may result from the failure of a brokerage house. Senate Report No. 1218. House Report No. 1613, 91st Cong., 2nd Sess. (1970). See also Securities Investor Protection Corp. v. Charisma Securities Corp., 352 F. Supp. 302 (S.D.N.Y.1972).

To effect its purpose, the Act established a fund created from mandatory assessments of all broker-dealers, to be utilized for the purpose of reimbursing customers who incur losses at the hands of insolvent brokers. The fund is administered by the Securities Investor Protection Corp., a nonprofit corporation whose members consist of all broker-dealers and members of national securities exchanges.

Upon determination that a broker is in danger of insolvency, SIPC is authorized to apply to the Court for an adjudication that the customers of the allegedly insolvent broker should be afforded the protection of the Act. See SIPC v. Charisma Securities Corp., supra. On June 21, 1971, this Court, upon such an application, appointed the Trustee, the movant herein, pursuant to Section 5(b)(3) of the Act. 15 U.S.C. § 78eee(b)(3).

III. ARENSTEIN'S CLAIM

Arenstein contends that his claim against Packer Wilbur should be recognized as a valid claim upon the "single and separate fund" established pursuant to the Act. 1970 Act, § 6(c)(2)(B), (f); 15 U.S.C. § 78fff(c)(2)(B), (f). Arenstein concedes that to the extent that Coggeshall's claim is allowed, his claim should be reduced accordingly. We do not agree.

We find from the facts aforementioned that Arenstein was attempting to effect a purchase and sale of stock and realize a profit thereon without any cash investment. If the transaction had been successfully completed, Coggeshall would have received payment for the stock from Packer Wilbur, leaving a zero balance in his Coggeshall account; Packer Wilbur would have completed the sale, leaving Arenstein's net profit of $3,269.82 in his Packer Wilbur account.

Section 220.4(c) of the Federal Reserve Board regulations (hereafter "Regulation T"), promulgated pursuant to the Exchange Act of 1934, 15 U.S.C. § 78g, provides:

"(c) (1) In a special cash account, a creditor may effect for or with any customer bona fide cash transactions in securities in which the creditor may:
(i) Purchase any security for, or sell any security to, any customer, provided funds sufficient for the purpose are already held in the account or the purchase or sale is in reliance upon an agreement accepted by the creditor in good faith that the customer will promptly make full cash payment for the security and that the customer does not contemplate selling the security prior to making such payment.
(ii) Sell any security for, or purchase any security from, any customer, provided the security is held in the account or the creditor is informed that the customer or his principal owns the security and the purchase or sale is in reliance upon an agreement accepted by the creditor in good faith that the security is to be promptly deposited in the account."

Accordingly, a customer purchasing a security for a cash account must pay for it immediately or within the period usually required to complete an ordinary securities transaction. Such undertaking is a necessary part of the customer's agreement with the broker-dealer pursuant to Regulation T. 1940 FRB 1172.

We find that the transaction at issue violated Regulation T. Arenstein never intended to "promptly make full cash payment" for the securities purchased, and the purchase price has not been tendered to date. (See Trustee's Affidavit, p. 2.) His intent was to realize a profit through the purchase and sale of securities with a zero cash investment.

Arenstein contends that the alleged violations, if any, were inadvertent and should not disqualify him from reimbursement of his loss by SIPC. We find this unacceptable. Arenstein had been an active securities trader for many years. (See Arenstein affidavit, ¶ 4.) He should have been familiar with the margin rules. Moreover, this is not a situation wherein a customer inadvertently failed to tender payment for a stock purchase. Rather, Arenstein consciously sought to avoid his obligation by effecting the purchase and sale through separate brokers.

The Act was intended to protect the innocent investor. One who engages in a fraudulent transaction cannot reap the benefits of the Act's intended protection. Thus in A. T. Brod & Co. v. Perlow, 375 F.2d 393 (2d Cir. 1967) a brokerage firm brought an action against one of its customers for violating the margin rules. The customer had placed purchase orders without intending to pay for the stock if its market value declined by the settlement date. The Court upheld the complaint on the ground that such practices "exacerbate the very evils that the securities laws were designed to prevent." A. T. Brod & Co. v. Perlow, supra at 397. See also Surgil v. Kidder Peabody & Co., Inc., 69 Misc.2d 213, 329 N.Y.S.2d 993. While these cases do not interpret the Act presently before us, to allow recovery thereunder for a claim based on the scheme initiated by Arenstein would likewise offend this Act's laudatory objective to reimburse an innocent customer for loss sustained.

Arenstein's reliance upon Pearlstein v. Scudder & German, 429 F.2d 1136 (2d Cir. 1970) is not well founded. The Second Circuit there held that an investor has a private right of action against his broker for violation of the margin regulations, regardless of the investor's sophistication or knowing participation in the transaction. Id. at 1140-1141. Arenstein contends that if a customer's alleged violation of the margin rules does not bar an action against the broker, it should not bar the customer's right to make claim on SIPC. The decision in Pearlstein to place absolute liability on broker-dealers rested upon the Court's implicit policy determination that the margin regulations are most effectively enforced by imposing absolute liability upon the broker regardless of the speculator's conduct. See Pearlstein v. Scudder & German: Implied Rights of Action for Violation of Federal Margin Requirements and the Demise of the In Pari Delicto Defense, 66 Northwestern U.L.Rev. 372 (1971); also Federal Margin Requirements as a Basis for Civil Liability, 66 Columbia L.Rev. 1463 (1966).

The instant case, however, does not involve apportionment of liability between broker and customer or any policy determination that one rather than the other should be held liable. Rather, the question before us is whether the overriding purpose of the Act — to reinforce the confidence of investors and strengthen the financial responsibility of the brokerage industry — is best served by prohibiting recovery out of SIPC funds by a customer who...

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