Pearlstein v. Scudder & German

• Decision Date: 24 July 1968
• Docket Number: 62 Civ. 1383.
• Citation: 295 F. Supp. 1197
• Parties: Stanley S. PEARLSTEIN, Plaintiff, v. SCUDDER & GERMAN, a partnership, Defendant.
• Court: U.S. District Court — Southern District of New York

295 F. Supp. 1197

Stanley S. PEARLSTEIN, Plaintiff, v. SCUDDER & GERMAN, a partnership, Defendant.

62 Civ. 1383.

United States District Court S. D. New York.

July 24, 1968.

COPYRIGHT MATERIAL OMITTED

Aranow, Brodsky, Bohlinger, Einhorn & Dann, New York City, for plaintiff; Robert J. Ward, Martin Berlin, New York City, of counsel.

Rembar & Zolotar, New York City, for defendant; George Zolotar, New York City, of counsel.

COOPER, District Judge.

Plaintiff, Stanley Pearlstein, institutes this action to recover damages, alleging that defendant, Scudder & German, illegally extended credit to plaintiff in violation of section 7(c) of the Securities Exchange Act of 1934 (hereinafter SEA), 15 U.S.C. § 78g(c), and Regulation T issued thereunder by the Board of Governors of the Federal Reserve System, 12 C.F.R. § 220. In addition, plaintiff alleges that defendant's handling of his account constituted a fraud on plaintiff in violation of section 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q (a), and sections 10(b) and 15(c) (1) of the SEA, 15 U.S.C. §§ 78j(b) and 78o(c) (1).

On February 20, 1961, plaintiff, a licensed, nonpractising attorney, opened a cash account with defendant, a partnership engaged as a broker-dealer in the securities business. On the same day plaintiff purchased through defendant 20 Richfield Oil convertible bonds for $28,345.84 and 20 Phillips Petroleum convertible bonds for $24,163.33, a total of $52,509.17 (Ex. 1).¹ Payment for the bonds was made as follows: $42,000 was obtained from a bank loan for which the bonds were used as collateral; the remainder of the purchase price, $10,509.17, was paid by check dated February 27, 1961 (Ex. 2).

On March 6, 1961, plaintiff sold the Phillips bonds through defendant. Plaintiff realized $24,598.53 therefrom, of which $20,000 was used to reduce the bank loan and obtain the release of the Phillips bonds. The sum of $4,598.53 was retained in plaintiff's account with defendant. Also on March 6th, plaintiff purchased through defendant, acting as broker, 50 convertible bonds of the Lionel Corporation (hereinafter Lionel bonds). The total cost of the bonds, including accrued interest and commissions, was $59,625.41. Defendant arranged a $48,000 bank loan against the bonds (Ex. 5), leaving a balance of $7,026.88² due from plaintiff. The bonds were registered on the New York Stock Exchange (hereinafter NYSE), and the delivery or settlement date was March 10, 1961.

On March 7, 1961, plaintiff purchased from defendant, as dealer, on a when-issued basis, 100 convertible bonds of the American Machine and Foundry Corporation (hereinafter AMF bonds) for $150,082.64. The bonds, registered on the NYSE, were made available for distribution on March 23, 1961. Defendant had advised plaintiff against the wisdom of both the Lionel and AMF purchases, and, with plaintiff's knowledge and consent, defendant's sale of the AMF bonds to plaintiff was a short sale.

Plaintiff entered New York Hospital on March 8, 1961 and underwent surgery on March 10th. He was discharged from the hospital on March 31st, but returned on April 9th, on an emergency basis, and underwent emergency operations on April 10th, April 13th, and April 20th. He was discharged from the hospital on June 10, 1961.

Beginning in May, 1961, defendant attempted by letters and telephone calls to secure payment from plaintiff of at least some portion of the money due on the AMF bonds. By August 7, 1961, however, plaintiff had made no payment on account thereof nor had he paid the balance due on the Lionel bonds. On August 7, 1961, defendant sent plaintiff notice that it intended to sell the AMF bonds on August 9th unless payment was received by that date or as soon thereafter as practicable (Exs. 13, 14). Also on August 7th, plaintiff was served with a summons and complaint in an action by defendant in the Supreme Court of the State of New York, New York County, to recover $7,138.57 owing in connection with the Lionel bonds, plus interest (Ex. 15).

Plaintiff entertained doubts about the legality of the AMF transaction and had, prior to this time, consulted an attorney, Truman Luhrman. In addition, plaintiff, on August 8, 1961, made inquiry of the Securities and Exchange Commission (hereinafter SEC). NYSE and National Association of Securities Dealers (hereinafter NASD) about the AMF transaction. These interviews apparently led him to believe that there was nothing illegal about the transaction.

The next day, August 9, 1961, plaintiff executed a stipulation settling the Lionel action (Ex. 17). The stipulation called for instalment payments which were duly made. Also on August 9th, plaintiff executed an agreement with defendant relating to the AMF bonds (Ex. 16): Plaintiff agreed to pay $25,000 in cash by the close of business on August 11, 1961 and defendant agreed to extend to plaintiff a $25,000 three-month loan. In addition, defendant agreed to make efforts to obtain a $100,000 bank loan, secured by the AMF bonds. The money was paid on August 11, 1961 and the required promissory notes were executed (Exs. 18, 22, 23).

In early November, 1961, plaintiff requested, and defendant granted a three-month extension of the $25,000 loan due on November 9th. Pursuant to that agreement, defendant instituted an action on November 8, 1961 against plaintiff in the Supreme Court of the State of New York, New York County, by the service of a summons (Ex. 24), to recover the $25,000. Also in pursuance of the agreement, plaintiff on November 8th signed a stipulation settling the action and agreeing to pay the $25,000 by February 8, 1962 (Ex. 25).

Plaintiff made part payment of $2,500 under the stipulation of settlement, but failed to pay the balance. Judgment was entered in the Supreme Court, February 26, 1962, against plaintiff, in accordance with the stipulation, in the sum of $22,712.81. The amount of the judgment was subsequently paid by plaintiff. In April, 1962, shortly after the instant suit was begun, plaintiff moved in the Supreme Court (Index No. 3520/1962) to vacate the judgment. Justice Hecht, on May 1, 1962, denied the motion.

Between May 29, 1962 and April 19, 1963, the banks which held the $48,000 Lionel note and the $100,000 AMF note sold the bonds for plaintiff's account. By this action plaintiff seeks to recover damages in the amount of $59,000 on the AMF bonds and $26,466.27 on the Lionel bonds, representing the difference between the purchase price of the bonds and the price at which the banks sold them.

Regulation T

Section 7(a) of the SEA, 15 U.S.C. § 78g(a), provides that "for the purpose of preventing the excessive use of credit for the purchase or carrying of securities," the Board of Governors of the Federal Reserve System shall prescribe rules and regulations governing the extension and maintenance of credit.

Congress has additionally provided, in section 7(c) of the SEA, 15 U.S.C. § 78g (c), that:

"It shall be unlawful for any member of a national securities exchange or any broker or dealer who transacts a business in securities through the medium of any such member, directly or indirectly to extend or maintain credit or arrange for the extension or maintenance of credit to or for any customer—

(1) On any security (other than an exempted security) registered on a national securities exchange, in contravention of the rules and regulations which the Board of Governors of the Federal Reserve System shall prescribe under subsections (a) and (b) of this section."

Regulation T, 12 C.F.R. § 220, issued by the Board of Governors pursuant to section 7(a), provides, in pertinent part, that:

"In case a customer purchases a security (other than an exempted security) in the special cash account and does not make full cash payment for the security within 7 days³ after the date on which the security is so purchased, the creditor⁴ shall, except as provided in sub-paragraphs (3)-(7) of this paragraph, promptly cancel or otherwise liquidate the transaction or the unsettled portion thereof." 12 C. F.R. § 220.4(c) (2).

In addition, even if the customer were thereafter to offer full payment, the broker-dealer must not accept such payment and consider the provisions requiring cancellation or liquidation to have been met. 1940 FRB 772, noted at 2 CCH Fed.Sec.L.Rep. ¶ 22,216.16.

Thus the crucial date by which payment of the unpaid balance on the Lionel bonds had to be made was March 15, 1961. As of that date, however, payment had not been made. Consequently, defendant's failure to cancel or liquidate at that time constituted a violation of Regulation T and of section 7(c).⁵

With respect to the purchase of the AMF bonds on a when-issued basis, the applicable rule is stated in 12 C.F.R. § 220.4(c) (3):

"If the security when so purchased is an unissued security, the period applicable to the transaction under subparagraph (2) of this paragraph shall be 7 days after the date on which the security is made available by the issuer for delivery to purchases sic."

The AMF bonds became available for delivery on March 23, 1961, but no payment had been made by plaintiff as of April 4, 1961. Defendant's failure to cancel or liquidate at that time constituted a violation of Regulation T and of section 7(c).

Private Right of Action

It is now well settled that although the SEA does not expressly give a right or remedy to a private person injured by a violation of section 7(c), such a right may nonetheless be implied. Applying the principle of 2 Restatement, Torts § 286 (1934) that where violation of a prohibitory statute has caused injury to an individual, the latter has a right of action if one of the purposes of the enactment was to protect individual interests (like the plaintiff's), the courts have held that a private right of action is to be inferred from section 7 of the SEA. Smith v. Bear, 237 F.2d 79 (2d Cir. 1956); Cooper v. North Jersey Trust Co., 226 F.Supp. 972 (S.D.N.Y.1964); Reader v. Hirsch & Co., 197...