Palmer v. Thomson & McKinnon Auchincloss, Inc.

• Citation: 474 F. Supp. 286
• Decision Date: 18 July 1979
• Docket Number: Civ. No. H-74-42.
• Court: U.S. District Court — District of Connecticut
• Parties: Raymond L. PALMER and Cora R. Palmer v. THOMSON & McKINNON AUCHINCLOSS, INC.

474 F. Supp. 286

Raymond L. PALMER and Cora R. Palmer v. THOMSON & McKINNON AUCHINCLOSS, INC.

Civ. No. H-74-42.

United States District Court, D. Connecticut.

July 18, 1979.

COPYRIGHT MATERIAL OMITTED

W. Wilson Keithline, Hartford, Conn., for plaintiffs.

Ernest A. Inglis, Jr., Philip S. Walker, Day, Berry & Howard, Hartford, Conn., for defendant.

RULING ON CROSS-MOTIONS FOR PARTIAL SUMMARY JUDGMENT

BLUMENFELD, District Judge.

Plaintiffs, Raymond L. and Cora R. Palmer (the Palmers) commenced this action against Thomson & McKinnon Auchincloss, Inc. (Thomson), a brokerage firm, for rescission and damages on several transactions involving the purchase and sale of securities. In a previous decision in this case, this court held that defendant Thomson violated Regulation T of the Federal Reserve Board, 12 C.F.R. § 220 et seq., and Section 7 of the Securities Exchange Act, 15 U.S.C. § 78g, and that plaintiffs could maintain a cause of action for those violations. Ruling on Cross-Motions for Summary Judgment on Count Three of plaintiffs' Complaint, Palmer v. Thomson & McKinnon Auchincloss, Inc., 427 F.Supp. 915 (D.Conn. 1977). That decision left open (1) whether the defendant could maintain a valid in pari delicto defense, and (2) in the event that an in pari delicto defense was found not to exist, the measure of damages. Plaintiffs and defendant have moved separately pursuant to Fed.R.Civ.P. 56(c) for summary judgment on these issues, which is appropriate here since there exists no genuine issue as to any material fact on the present state of the record.

Factual Background

Plaintiffs Raymond and Cora Palmer are a retired couple in their seventies. On March 21, 1972, they transferred their margin account with Shearson Hamill & Co., Inc. to the defendant. This transfer resulted in a deposit with the defendant of 2,500 shares of Jack Eckerd Corp. (Eckerd) and an extension of credit by defendant to plaintiffs of $30,735. The Eckerd stock then had a value of $33 per share and a total value of $82,500. The margin requirement of the Federal Reserve Board promulgated pursuant to § 220.8 of Regulation T was 55 percent. On March 21, 1972, the credit extended by the defendant to the plaintiffs was within the limits set by Regulation T.

On that date, defendant credited plaintiffs' SMA¹ in the amount of $6,390. This credit of $6,390 represented the difference between the excess loan value of the securities, $37,125, and plaintiffs' adjusted debt balance of $30,753.²

On March 28, 1972, the value of the Eckerd stock rose to $85,000. Forty-five percent of the $2,500 increase was credited to the Palmers' SMA ($1,125). April 5, 1972, the shares' value rose an additional $2,500 to $87,500. Again $1,125 was added to the SMA. The next day, April 6, 1972, the value of plaintiffs' securities jumped $5,000 to $92,500. Forty-five percent of this increase, or $2,250, was added to the SMA which now totaled $10,871.75.³ By April 28, 1972, the value of plaintiffs' Eckerd stock had declined $10,000 and returned to its initial worth of $82,500. No entry was made to the SMA to reflect this loss in value. In addition, a dividend of $87.41 was credited to the SMA and subtracted from the adjusted debit balance. Thus as of May 9, 1972, plaintiffs had an SMA of $10,959.26 and a debit balance of $30,839.79.

On May 9, 1972, defendant purchased 500 more shares of Eckerd stock for the plaintiffs at a cost of $16,952.75. To meet the 55 percent margin requirement of Regulation T, defendant debited plaintiffs' SMA $9,324.01 (55 percent of $16,952.75). After the purchase, plaintiffs had a debit balance of $47,792.54 ($30,839.79 + $16,952.75) and an SMA of $1,635.25 ($10,959.26 - $9,324.01). It is clear that if the SMA had been adjusted to reflect the decline in value of plaintiffs' prior holdings in Eckerd, they would not have had sufficient equity in their accounts to purchase the new shares under the 55 percent margin requirement.

Between May 9, and November 14, 1972, the only entries to plaintiffs' margin accounts consisted of interest charges of $1,782.21 and a dividend credit of $225. At plaintiffs' request, on November 15, 1972, the defendant sent plaintiffs a check for $200. This transaction was effected by reducing the SMA $200 and adding $200 to their debit balance.

Finally on November 28, 1972, defendant purchased 4,500 shares of Ward Cut-Rate Drug Co. (Ward) for plaintiffs' margin account at a cost of $111,936.60. On the same day, defendant created a "short" account for the plaintiffs and sold the 3,000 shares of Eckerd for $113,921.65.⁴ In conformity with the Regulation T "same day transaction" rules, defendant did not require the deposit of any additional equity to plaintiffs' account since the shares sold had a greater market value than those purchased. As the value of their Ward shares declined, plaintiffs fell below the house maintenance margin requirements of defendant.⁵ The short account was closed out March 9, 1973; the Ward shares were sold on April 24, 1973.

This court specifically held in its previous ruling that the May 9 purchase of "Eckerd" and the November 28 purchase of "Ward" were both in violation of Regulation T and Section 7 of the Securities Exchange Act. 427 F.Supp. at 924.

In Pari Delicto Defense

The defendant argues in its motion that because both the defendant and the plaintiffs share responsibility for complying with margin regulations, and because neither party believed a violation had occurred, the parties were in pari delicto with respect to the violations. Plaintiffs, on the other hand, argue that although they had knowledge of the transactions involving their margin account, their reliance upon the defendant's calculations cannot support a defense based on comparative fault.

The defense of in pari delicto is a valid defense in a private action for violation of the Securities and Exchange Act of 1934. Woolf v. S.D. Cohn & Company, 515 F.2d 591, 601-03 (5th Cir. 1975), vacated on other grounds, 426 U.S. 944, 96 S.Ct. 3161, 49 L.Ed.2d 1181 (1976); James v. DuBreuil, 500 F.2d 155 (5th Cir. 1974); Lantz v. Wedbush, Noble, Cooke, Inc., 418 F.Supp. 653 (D.Alaska 1976); Bell v. J.D. Winer & Co., Inc., 392 F.Supp. 646 (S.D.N.Y. 1975). In order to assert the defense it must be shown that the fault of the parties is "clearly mutual, simultaneous, and relatively equal" and that the plaintiff was an active, essential, and knowing participant in the unlawful activity. Woolf v. S.D. Cohn & Company, supra, 515 F.2d at 604; James v. DuBreuil, supra; Lantz v. Wedbush, Noble, Cooke, Inc., supra, 418 F.Supp. at 654.⁶

From these general principles, I find that the application of the in pari delicto defense is inappropriate to the case at bar. The defendant is correct in its assertion that the responsibility for complying with margin regulations is shared by investors as well as brokers.⁷ However, the assertion of "comparative innocence," i. e., that both parties believed the transactions met Regulation T requirements, will not support the imposition of an in pari delicto defense.

In the cases that have upheld the defense, the plaintiffs' conduct involved active, knowing and voluntary schemes to circumvent the securities laws.⁸ See James v. DuBreuil, supra; Kuehnert v. Texstar, supra, 412 F.2d 700; see also Woolf v. S.D. Cohn & Company, supra; Lantz v. Wedbush, Noble, Cooke, Inc., supra. In the instant case, the Palmers' mere acquiescence in transactions they believed legitimate cannot be characterized as active, knowing, simultaneous, and equal participation in the Regulation T violations. Thus, plaintiffs' conduct in relying on the defendant's calculations regarding margin requirements does not reach the level of culpability generally associated with an in pari delicto defense.

Damages

Plaintiffs argue in their motion that the proper measure of damages is that based upon rescission, i. e., to place them in the position they would have been in had the illegal transactions not been charged to their account. Under plaintiffs' theory of recovery, the entire May 9 purchase of 500 shares of Eckerd and the entire November 28 purchase of 4,500 shares of Ward would be rescinded, thereby allowing plaintiffs to recoup their losses amounting to $85,084.45 (the net value of 2,500 shares of Eckerd as of November 28, 1972). Under defendant's theory of recovery, plaintiffs would be entitled to $2,444.21, the maximum loss directly attributable to 163 shares of Eckerd purchased on May 9 in violation of Regulation T. See Stipulation To Accuracy of Computations, II. C. 6.

In support of their argument for rescission, plaintiffs rely primarily on Section 29(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78cc, which provides in relevant part:

"(b) Every contract made in violation of any provision of this chapter or of any rule or regulation thereunder, and every contract (including any contract for listing a security on an exchange) heretofore or hereafter made, the performance of which involves the violation of or the continuance of any relationship or practice in violation of, any provision of this chapter or any rule or regulation thereunder, shall be void . . .."

Plaintiffs do not allege here that the standard customer's agreement they entered into was violative of the Securities Exchange Act. Instead, they argue that Section 29(b) should not only apply to the basic contract between the parties but also to each transaction that occurs thereunder. Plaintiffs argue that each transaction should be considered a separate contract for purposes of Section 29(b).

Section 29(b) authorizes rescission of unlawful contracts, not unlawful transactions that were consummated under lawful agreements. See Drasner v. Thomson, McKinnon Securities, Inc., 433 F.Supp. 485 (S.D.N.Y. 1977). As Judge Pollack noted in Drasner:

"This subsection Section 29(b) only renders void those contracts which by their terms violate the Act or the rules and

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