Kavit v. AL Stamm & Co.

• Decision Date: 22 January 1974
• Docket Number: Docket 72-1994.,No. 149,149
• Court: U.S. Court of Appeals — Second Circuit
• Parties: Arthur Yale KAVIT, Plaintiff-Appellee, v. A. L. STAMM & CO., a Co-partnership, and Jack R. Levien, Defendants-Appellants.

491 F.2d 1176 (1974)

Arthur Yale KAVIT, Plaintiff-Appellee, v. A. L. STAMM & CO., a Co-partnership, and Jack R. Levien, Defendants-Appellants.

No. 149, Docket 72-1994.

United States Court of Appeals, Second Circuit.

Argued December 17, 1973.

Decided January 22, 1974.

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Norman Winer, New York City (Nathan, Mannheimer, Asche, Winer & Friedman, New York City, of counsel), for defendants-appellants.

David L. Tecklin, New York City, for plaintiff-appellee.

Before LUMBARD, FRIENDLY and OAKES, Circuit Judges.

FRIENDLY, Circuit Judge:

The opinion of this court in Ryan v. J. Walter Thompson Co., 453 F. 2d 444, 445 (2 Cir. 1971), began by saying:

This case is another example of a trend we have observed with disturbing frequency, namely, invocation of the salutary anti-fraud provisions of the federal securities laws in cases where those provisions are wholly inappropriate and wide of the Congressional mark. Moreover, the vice of this practice is compounded here by engrafting upon the misplaced federal securities law claim a state law claim that, but for the federal gloss, should have been litigated in the state courts.

The problem presented by this action by a customer against a stockbroker and a registered representative¹ fits this description and goes well beyond it. In Ryan, both the federal and state claims were disposed of on summary judgment. Here the federal claims were even weaker and in our view should have been dismissed on motion, while the pendent state claims were far more substantial — resulting, in fact, in recovery for the plaintiff. Moreover, the state claims would have gone to arbitration under the standard customer agreement if they had stood alone.² Permitting a plaintiff to try such claims on the basis of pendent jurisdiction not only adds to the burdens of the federal courts and deprives the parties of the opportunity to obtain in a more fitting tribunal "a surer-footed reading of applicable law," United Mine Workers v. Gibbs, 383 U.S. 715, 726, 86 S.Ct. 1130, 1139, 16 L.Ed.2d 218 (1966),³ but it strips the defendant of its contractual right to arbitration.

This court has not been grudging in its application of the pendent jurisdiction principles set out in United Mine Workers v. Gibbs, supra. See, e. g., Astor-Honor, Inc. v. Grosset & Dunlap, Inc., 441 F.2d 627 (2 Cir. 1971); Leather's Best, Inc. v. S. S. Mormaclynx, 451 F.2d 800, 809-811 (2 Cir. 1971); Almenares v. Wyman, 453 F.2d 1075, 1083-1085 (2 Cir. 1971), cert. denied, 405 U.S. 944, 92 S.Ct. 962, 30 L.Ed.2d 815 (1972). In none of those decisions, however, did a federal trial involve any risk of loss of rights beyond the possibility, in Astor-Honor and Leather's Best, that the federal court would misread state law. A quite different case is presented where, as here, dismissal or a stay of the state claims would enable the defendant to have those claims determined by arbitrators rather than by a court. It is true that Gibbs suggests that the determination whether to invoke pendent jurisdiction or not should generally rest in the sound discretion of the district court, see 383 U.S. at 727-728, 86 S.Ct. 1130, 16 L.Ed.2d 218, but the Court used mandatory language in directing that when the federal claims are dismissed before trial, "even though not insubstantial in a jurisdictional sense, the state claims should be dismissed as well." 383 U.S. at 726, 86 S. Ct. at 1139.

Quite apart from the arbitration problem, the flimsy nature of federal claims may call for dismissal of pendent state claims. See McFaddin Express, Inc. v. Adley Corp., 346 F.2d 424 (2 Cir. 1965), cert. denied, 382 U.S. 1026, 86 S.Ct. 643, 15 L.Ed.2d 539 (1966). In the cautionary part of his opinion in Gibbs, 383 U.S. at 726-727, 86 S.Ct. at 1139, which perhaps is not read enough, Mr. Justice Brennan noted that dismissal of common law claims might be merited if "pretrial procedures or even the trial itself . . . reveal a substantial hegemony of state law claims." The Justice added that "recognition of a federal court's wide latitude to decide ancillary questions of state law does not imply that it must tolerate a litigant's effort to impose upon it what is in effect only a state law case. Once it appears that a state claim constitutes the real body of a case, to which the federal claim is only an appendage, the state claim may fairly be dismissed." 383 U.S. 727, 86 S.Ct. 1139. If it appears that the federal claims are subject to dismissal under F.R.Civ.P. 12(b)(6) or could be disposed of on a motion for summary judgment under F. R.Civ.P. 56, the court should refrain from exercising pendent jurisdiction absent exceptional circumstances.⁴ Indeed, this is essential to avoid a result where, as has been happily said, "the dog would be wagged by his tail." Hart & Wechsler, The Federal Courts and the Federal System 925 (2d ed. 1973).⁵

An even greater degree of circumspection is demanded when, as here, exercise of pendent jurisdiction over a state claim will result in the claim being tried to a court rather than to arbitrators. In such cases the federal court normally should stay the trial of the state claims or dismiss them in the absence of any other ground of federal jurisdiction, if properly requested to do so, even when the federal claims cannot be disposed of without a trial. While exceptional circumstances might justify a contrary course, at the moment we cannot think of any.

It is with this background that we turn to the instant case, a rather minor fall-out of the Canadian mineral strike by Texas Gulf Sulphur Company TGS in April, 1964, which has consumed so much time of the district court — ironically, of Judge Bonsal in particular — and of this court. Plaintiff, Dr. Kavit, a veterinarian and speculator, had maintained accounts with four brokerage houses in Richmond, Va., including the Richmond office of Francis I. duPont & Co. Defendant Levien, who had become his registered representative there, left duPont in February 1964 and became a registered representative with defendant Stamm & Co. in New York City. To Stamm's misfortune, Dr. Kavit opened an account with it and later had his duPont accounts transferred there. The news of the TGS mineral strike and the sharp rise in the stock came not long after the Stamm account was opened. On April 10, 1964, TGS closed at 30 1/8; by April 17, it had climbed to a close of 40¼. Convinced at that point that the stock was ready to fall, Dr. Kavit made two short sales of 100 shares of TGS, one on April 20 at 42 5/8 and the other on April 21 at 39¾. Unhappily for Dr. Kavit the stock rebounded and the short sales were ultimately covered at 58¾, with a resulting loss of $3,602.26.

The complaint contained two counts under the Securities Exchange Act and two at common law. The first count, relying on § 10(b) and the ever-present Rule 10b-5, alleged that Levien had made a number of reckless predictions of the downward path that TGS shares would take, and that the April 21 short sale had been made without Dr. Kavit's consent. The fourth count alleged a violation of §§ 7 and 29 of the Securities Exchange Act. The theory underlying that claim was that between April 16 and May 6, 1964, Stamm knew that plaintiff's account was substantially undermargined, but that the company continued "encouraging and permitting purchases through the account." Plaintiff therefore claimed that the transactions in his account during that period were in violation of the margin requirements provision, 15 U.S.C. § 78g,⁶ and that the contracts of purchase and sale in plaintiff's account thus violated 15 U.S.C. § 78cc. The second and third counts, one alleging negligence and the other charging conversion, were based on a melange of Levien's predictions, the allegedly unauthorized short sale of April 21, and Levien's failure to carry out instructions that if the market went up, he would cover the two short sales in the range of 43-44.

Defendants moved to dismiss the complaint for failure to state a claim under the Securities Exchange Act and, with respect to diversity, see note 3, supra, for lack of the required jurisdictional amount. In the alternative, they sought an order "staying all proceedings under U.S.C. Title 9 and Rule 81(a)(3) pursuant to the arbitration clause contained in the contract of the parties dated April 10, 1964." The motion was supported by extensive affidavits, to which plaintiff responded, and memoranda of law were received from both sides. Judge Metzner denied the motion in an opinion dated April 3, 1967. Although he thought the allegations were "thin insofar as a fraud action is concerned," he believed them sufficient under what had just been stated in A. T. Brod & Co. v. Perlow, 375 F.2d 393, 398 (2 Cir. 1967). He said nothing about the claim under §§ 7 and 29, or about the motion for a stay. On rehearing, he noted merely that "the plaintiff has stated a claim under the Securities Exchange Act of 1934," and that the arbitration clause was "inoperative to bind the plaintiff to arbitration of this Rule 10b-5 claim." Consequently, he denied the motion "to stay all proceedings in this action pending arbitration." In support of his ruling, the judge referred to his opinion in Pawgan v. Silverstein, 265 F.Supp. 898 (S.D.N.Y.1967), see note 2 supra, which held an arbitration clause void with respect to an alleged § 10(b) violation. Pawgan also held, however, that the nonwaiver provisions of the federal securities law, 15 U.S.C. §§ 77n, 78cc(a), do not apply to pendent state claims, and that those claims are thus subject to valid arbitration agreements. The reference to Pawgan suggests that Judge Metzner might well have looked favorably upon a motion to stay or dismiss which was limited to the common law claims, but defendants took no such step.

Alternatively, the defendants could have pursued an appeal from Judge Metzner's orders. In fact, they filed notices of appeal both from the initial order and from the...