Securities & Exch. Com'n v. First Securities Co. of Chicago
| Citation | 463 F.2d 981 |
| Decision Date | 10 October 1972 |
| Docket Number | No. 71-1272.,71-1272. |
| Parties | SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. FIRST SECURITIES COMPANY OF CHICAGO, Defendant. Olga Hochfelder et al., Claimants-Appellants, Keith S. McKy, Receiver-Appellee, Customer Creditors Committee, Committee-Appellee. |
| Court | United States Courts of Appeals. United States Court of Appeals (7th Circuit) |
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Philip A. Loomis, Jr., Washington, D. C., John I. Mayer and Joseph L. Grant, Chicago, Ill., for Securities Exchange Commission.
Donald Vetter, Leon M. Despres, Albert Schwartz, Alex Elson, Willard Lassers, Aaron S. Wolff, Willard L. King, Stanley N. Gore, King, Robin, Gale & Pillinger, Elson, Lassers & Wolff, Chicago, Ill., for appellants.
Samuel H. Young, Charles Aaron, Michael L. Weissman, Aaron, Aaron, Schimberg & Hess, Chicago, Ill., for appellee.
Before SWYGERT, Chief Judge, and HASTINGS, Senior Circuit Judge, and SPRECHER, Circuit Judge.
Certiorari Denied October 10, 1972. See 93 S.Ct. 85.
This is an appeal from the disallowance of fifteen claims of individuals in the total amount of $972,500 asserted against the assets of a securities brokerage firm with regard to which an equitable receivership is in progress in the district court. The defendant in the equitable receivership, First Securities Company of Chicago (hereinafter, "First Securities"), was registered with the Securities and Exchange Commission as a broker-dealer in securities and was a member of the Midwest Stock Exchange and the National Association of Securities Dealers, Inc. On June 4, 1968, Leston B. Nay, President of First Securities and owner of 92 percent of its stock, murdered his wife and committed suicide, leaving a suicide note which described First Securities as being bankrupt because of his thefts and which described certain "escrows" which were his creation as "spurious." On June 10, 1968, the SEC initiated this receivership action against First Securities. The claims which are the subject matter of this appeal derive from Nay's creation of and dealings in a fraudulent escrow account. The district court appointed a special master to hear and determine the validity of these claims. In accordance with the recommendation and findings of the special master, the district court disallowed all of the instant claims in their entireties, and this appeal followed.
The special master specifically found most of the following facts to be established by the evidence, which findings the district court approved. The remaining facts stated here are undisputed in the record. The fifteen claimants had each been brokerage clients of First Securities, buying and selling securities through First Securities in regular fashion. Each received investment advice from Nay, and each knew Nay to be the president of First Securities. Nay advised each of the claimants that he was able to offer to the claimant an opportunity to invest in a so-called escrow which would yield a high rate of interest (generally twelve percent per annum, but later reduced to nine percent). As to fourteen of the claimants he recommended investment in the escrow when the claimants were actually in the offices of First Securities. He explained that the escrow opportunity had come to him because he had done a favor for a small investment company through First Securities. Although Nay was always somewhat vague and secretive about the details of the escrow (he explained that the escrow was necessarily a "secret" between First Securities and an unnamed finance company), he described the escrow as being a fund which was to be used as the principal from which a small loan company would make loans. He further explained that the loan company could charge up to 2½ percent per month interest under the law, thus enabling the investors in the escrow to realize the high rates of interest promised. Typically, upon being persuaded by Nay that the escrow was the best possible investment for them, the claimants sold legitimate securities through First Securities for purposes of obtaining the necessary cash to invest in the escrow. First Securities effected the sales, collected its commissions and submitted the proceeds to the claimants, who then drew their personal checks payable to Nay or to a bank for his account. Subsequent transactions with regard to the escrow were not in the form usual to dealings between customers and First Securities, nor was the escrow reflected in periodic accountings by First Securities to the claimants.
Upon receipt of the cash investment from the claimants Nay usually executed a handwritten document which acknowledged such receipt and confirmed the terms of the arrangement. Sometimes Nay gave promissory notes to the claimants. All, or substantially all, of Nay's correspondence with the claimants was written on letterhead stationery of First Securities. Some of the letterhead stationery included the words, "Leston B. Nay, President," on the upper left hand portion thereof. All of the stationery bore the legend, "Member Midwest Stock Exchange," in addition to the firm's name and address. Although much of Nay's correspondence with regard to the escrow transactions was handwritten by him, a substantial portion was typed by his secretary at First Securities.
During the early years of Nay's fraudulent enterprise, the claimants were paid interest from time to time based upon their "investments" in the escrow. Such payments were made by Nay's personal check sent in an envelope upon which First Securities' name and address appeared in the upper left hand corner in the position normally occupied by the return address of the sender. The interest payments were erratic and delinquent during the later years of the operation of the scheme. During the period of 1953 through 1967, with the exception of 1955, Nay's files revealed that he sent Treasury forms 1099 to each of the claimants which showed that the distributions of interest to them had been reported as a deduction from his personal income tax return. The claimants reported the interest payments on their income tax returns in accordance with the forms 1099 received from Nay. In connection with Internal Revenue Service audits of Nay's individual federal income tax returns for 1956 and 1965, he sent form letters to each of the claimants asking that they verify the amount of his indebtedness to them and the amount of interest he had paid them during the year in question. Each of the claimants returned the letters marked and signed to indicate their concurrence with the amounts shown thereon as received from Nay. Also, from time to time some of the claimants referred to their escrow investments in correspondence with Nay as being personal loans to him.
As to some of the claimants, Nay's receipt for investments in the escrow took the form of a purported agreement or promissory note from Nay to the claimant which recited, "This agreement is binding and inures to the benefit of your and my heirs, executors and assigns." Upon direct inquiries from several claimants, Nay vaguely indicated that the escrow would be settled in the event of his death either by the bank which was supposed to be the locus of the escrow account, or by his wife or his lawyer. He told one claimant that in such event a claim should be filed against his estate. On the other hand, he advised some that since the funds were in escrow they would be handled outside the probating of his estate. He also told one claimant who was seeking to withdraw some of his investment from the escrow that his money "was safe at First Securities." By the same token, Nay from time to time had successfully dissuaded claimants from with-drawing money from the escrow to invest in other things.
Finally, it is clear that Nay had no actual authority to act for First Securities with regard to the escrow account. It is also clear that First Securities' employees (other than Nay) knew nothing of the nature of the escrow nor, except for his secretary, even of its existence. Nay had forbidden anyone other than himself to open mail addressed to him, and in his absence all such mail was simply allowed to pile up on his desk, even if it was addressed to First Securities for his attention.
The claimants assert that the foregoing facts entitled them to recover from First Securities their losses due to Nay's fraud. They urge the propriety of that result on two grounds: that Nay acted with apparent authority as the common law agent of First Securities and that Nay and First Securities violated or are liable for violations of Section 10(b) of the Securities Exchange Act of 1934, Rule 10b-5 of the Securities and Exchange Commission and Rule 27 of the Rules of Fair Practice of the National Association of Securities Dealers, Inc. The special master and the district court rejected claimants' view on both theories and dismissed the claims. We reverse.
Claimants' assertion that First Securities is liable as his principal for Nay's fraud is based in part on sections 261 and 262 of the Restatement of Agency, Second (1958). Section 261 states:
A principal who puts a servant or other agent in a position which enables the agent, while apparently acting within his authority, to commit a fraud upon third persons is subject to liability to such third persons for the fraud.
Section 262 provides:
A person who otherwise would be liable to another for the misrepresentation of one apparently acting for him is not relieved from liability by the fact that the servant or other agent acts entirely for his own purposes, unless the other has notice of this.
Example one of the illustrations given under section 262 is as follows:
P, whose business is that of advising persons concerning investments, represents to T that A is his manager. At P\'s office T seeks advice of A concerning investments. A, acting solely to promote an enterprise of which he is the owner,...
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