SECURITIES & E. COM'N v. Kelly, Andrews & Bradley, Inc.

• Decision Date: 25 November 1974
• Docket Number: No. 71 Civil 5469.,71 Civil 5469.
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff, Securities Investor Protection Corporation, Applicant, v. KELLY, ANDREWS & BRADLEY, INC., et al., Defendants.
• Court: U.S. District Court — Southern District of New York

385 F. Supp. 948

SECURITIES AND EXCHANGE COMMISSION, Plaintiff Securities Investor Protection Corporation, Applicant, v. KELLY, ANDREWS & BRADLEY, INC., et al., Defendants.

No. 71 Civil 5469.

United States District Court, S. D. New York.

November 25, 1974.

COPYRIGHT MATERIAL OMITTED

William D. Moran, Regional Administrator Securities and Exchange Comm., New York City, for plaintiff.

Nathan Leventon, New York City, for claimant Steiner, Rouse & Co., Inc.

Bressler, Meislin, Tauber & Lipsitz, New York City, for claimant Philips, Appel & Walden, Inc.; Steven H. Lipsitz, New York City, of counsel.

Vincenti & Schickler, New York City, for claimant Feis Securities Co.

Theodore H. Focht, Washington, D. C., for Securities Investor Protection Corp.; Wilfred R. Caron, Associate Gen. Counsel, Washington, D. C., Michael E. Don, Attorney, Washington, D. C., of counsel.

Casperini, Koch & Savage, New York City, for the trustee; Patrick W. McGinley, Stephen F. Downs, New York City, of counsel.

OPINION

EDWARD WEINFELD, District Judge.

Upon the commencement of this action by the Securities and Exchange Commission against Kelly, Andrews & Bradley, Inc. ("Kelly, Andrews"), a broker-dealer, and its officers and directors, charging them with violations of the anti-fraud and other provisions of the Securities Acts of 1933 and 1934, a Trustee was appointed to liquidate Kelly, Andrews to protect its customers, pursuant to the provisions of the Securities Investor Protection Act of 1970 ("SIPA").¹ After a trial on the merits, judgment was entered granting a permanent injunction in various respects against the defendants.² The matter now before the court is on the application of the Trustee to disallow, after hearing on notice, various claims filed for coverage pursuant to SIPA.³ Three claimants object to the disallowance of their respective claims and each will be considered separately.

Before considering their objections, a word about this relatively recent legislation under which the disputes arise is in order. SIPA was enacted to protect public customers of securities dealers from the consequences of financial instability in the broker-dealer industry⁴ by assuring to customers recovery in the event of a broker-dealer's insolvency. The central provision of SIPA creates the Securities Investor Protection Corporation ("SIPC"), a non-profit corporation composed of all broker-dealers registered with the Securities and Exchange Commission under the Securities and Exchange Act of 1934 and all members of a national securties exchange.⁵ When SIPC determines that a broker is on the brink of insolvency or otherwise is in need of the protection the Act affords, SIPC applies to a federal district court for a determination that the broker's customers are entitled to such protection. A trustee is then appointed.⁶ If the trustee determines that a customer's claim against the broker is covered by the Act's provisions, SIPC advances funds to the trustee for payment of the claim, up to $50,000 for each customer owed securities and $20,000 for each customer owed cash from the financially precarious brokerage firm.⁷ SIPC is funded by assessments made upon the members of the broker-dealer industry.⁸

1. Claim of Steiner, Rouse & Co., Inc.

This claimant, a broker-dealer, alleges that on September 23, 1971, acting as agent on behalf of its customers, it sold to Kelly, Andrews, the debtor, 4300 shares of International Technical Development stock for $2,265; that the debtor refused to accept delivery of such shares; that after repeated unsuccessful attempts to make delivery, Steiner, Rouse sold the securities on October 28, 1971 to another broker-dealer at a loss of $1,234.75. The Trustee does not dispute these facts or that the amount of the loss is allowable against the debtor's estate. The issue is whether the claimant is entitled to coverage under SIPA.

First, the claimant contends that it is a "customer" of the debtor within the meaning of section 6(c)(2)(A)(ii) of SIPA⁹ and consequently is entitled to payment pursuant to section 6(f)(1)(D) of the Act,¹⁰ which affords protection to brokers who are "customers" of the debtor and who were acting for their own customers in the transaction. Section 6(c)(2)(A)(ii) of the Act in pertinent part provides:

"`customers' of a debtor means persons (including persons with whom the debtor deals as principal or agent) who have claims on account of securities received, acquired, or held by the debtor from or for the account of such persons (I) for safekeeping, or (II) with a view to sale, or (III) to cover consummated sales, or (IV) pursuant to purchases, or (V) as collateral security, or (VI) by way of loans of securities by such persons to the debtor, and shall include persons who have claims against the debtor arising out of sales or conversions of such securities, . . . ." emphasis supplied

Steiner, Rouse never delivered the securities to the debtor. It retained them until it effected their sale of October 28, 1971 and sustained the loss. The loss sustained upon their sale is not a claim "on account of securities received, acquired, or held by the debtor." Therefore claimant is not a customer as defined in the Act and is not entitled to SIPA coverage for its loss. Its claim is against the debtor's estate as a general unsecured creditor.

Second, Steiner, Rouse contends that the transaction was an "open contractual commitment" and that therefore the Act obligates the Trustee to complete the transaction and make good claimant's loss. Under section 6(d) of SIPA,¹¹ the Trustee is required to:

"complete those contractual commitments of the debtor relating to transactions in securities which were made in the ordinary course of debtor's business and which were outstanding on the filing date —

(1) in which a customer had an interest, except those commitments the completion of which the Securities and Exchange Commission shall have determined by rule or regulation not to be in the public interest, or (2) in which a customer did not have an interest, to the extent that the Commission shall by rule or regulation have determined the completion of such commitments to be in the public interest."

Steiner, Rouse was acting as an agent for a customer in this transaction and, under section 6(d)'s unique definition of a "customer,"¹² the claim here at issue would qualify for SIPC payment if the transaction were an open contractual commitment.

Congress intentionally left the definition of an "open contractual commitment" subject to contraction and expansion by the SEC through rules and regulations, as experience dictated.¹³ The Commission did not promulgate rules with respect to this provision until July, 1973.¹⁴ These regulations may not be applied retroactively,¹⁵ and the Commission does not seek to do so.¹⁶ Regardless of the inapplicability of the rule, the court concludes that the transaction is not an "open contractual commitment."

The section refers to contracts between the debtor and another broker-dealer (acting for itself or a customer) for the purchase and sale of securities. It directs the Trustee to complete those contracts which are outstanding as of the filing date. Its purpose is to avoid the so-called "domino effect" whereby the insolvency of one broker would cause the collapse of another because of the former's inability to complete open transactions by the payment of cash or the delivery of securities.¹⁷ It is clear that to avoid the "domino" impact the section contemplated completion by the Trustee of outstanding executory contracts. In the instant case there was no executory contract outstanding on the filing date, December 15, 1971. As already noted, after the debtor breached the September 23, 1971 contract by refusing to accept the securities, Steiner, Rouse sold them to another broker on October 28, 1971, and sustained the loss for which it filed the instant claim. Thus, as of the filing date, Steiner, Rouse was no longer under commitment to deliver, and the debtor was no longer under commitment to accept the securities. There no longer existed an open contractual commitment with the debtor; Steiner, Rouse had a claim for damages for breach of contract.¹⁸ To require the Trustee to use SIPC funds to pay damages for a breach of contract claim against the debtor would not serve the congressional purpose of avoiding the domino effect inherent in unfulfilled open contractual commitments and would only serve to give a windfall to those who are general creditors based upon breach of contract claims.

The court's conclusion is required by a recent decision of our circuit, SEC v. Packer, Wilbur & Co.¹⁹ In Packer, Wilbur, claimant had delivered stock to the debtor in return for checks that the debtor knew would be dishonored for insufficient funds. Claimants sought compensation under section 6(d)'s open contractual commitment provision, but coverage was denied. The court interpreted section 6(d) as requiring completion of wholly executory contracts only. Packer, Wilbur, upon its facts, was a much stronger case for the application of section 6(d) benefits, but the court held that even partially executed contracts are not open contractual commitments.²⁰ Since the transaction here at issue was not wholly executory as of the filing date, it does not qualify as an open contractual commitment within the meaning of section 6(d) of the Act. Steiner, Rouse's claim is not entitled to coverage thereunder.

2. Claims of Philips, Appel & Walden, Inc.

Two separate transactions are involved here.

(a) On September 28, 1971, the debtor refused to accept from Philips, Appel & Walden ("PAW") 300 shares of Working Girl, Inc., which the debtor had previously purchased on order. The shares were then sold by PAW at a loss of $719.25 and it now contends that the transaction is an open contractual commitment which the Trustee is obligated to complete. For the same reasons which required rejection of the Steiner, Rouse...