Consolo v. Hornblower & Weeks-Hemphill, Noyes, Inc.

Decision Date09 December 1976
Docket NumberCiv. A. No. C76-763.
Citation436 F. Supp. 447
PartiesRalph G. CONSOLO, Plaintiff, v. HORNBLOWER & WEEKS-HEMPHILL, NOYES, INC., et al., Defendants.
CourtU.S. District Court — Northern District of Ohio

Michael T. Honohan, Alan N. Hirth, Benesch, Friedlander, Coplan & Aronoff, Cleveland, Ohio, for Ralph G. Consolo.

Frederick W. Assini, Calfee, Halter & Griswold, Cleveland, Ohio, Beekman & Bogue, New York City, for Hornblower & Weeks-Hemphill, Noyes, Inc., Lawrence Milne and Robert Bullock.

MEMORANDUM AND ORDER

KRUPANSKY, District Judge.

This is a proceeding instituted pursuant to the Securities Act of 1933, 15 U.S.C. § 77a et seq., the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq., and the Commodity Exchange Act of 1936, 7 U.S.C. § 1 et seq. The jurisdiction of this Court is purportedly invoked pursuant to 15 U.S.C. § 77v(a) and 15 U.S.C. § 78aa. Plaintiff asserts no jurisdictional basis for his separate cause of action under the Commodity Exchange Act. The remaining causes of action are premised upon the pendant jurisdiction of the federal courts.

A review of the pleadings filed herein discloses that this matter is presently the subject of arbitration proceedings before a panel of the American Arbitration Association in New York City (Hornblower & Weeks-Hemphill, Noyes Incorporated v. Ralph G. Consolo; Case No. 1310-0145-75), and that said proceedings were instituted pursuant to the contractual agreement of the parties. Simultaneous with the filing of his Complaint, plaintiff filed a Motion to Stay Arbitration, with a supporting memorandum of law appended thereto. In their Answer, defendants challenged the jurisdiction of this Court and filed their Motion to Stay the Action Pending Arbitration, with supporting affidavits and a memorandum of law appended thereto. In addition, defendants filed a Motion for Protective Order, pending the Court's ruling upon the two motions for a stay of proceedings. In response to the foregoing motions, an evidentiary hearing was held to determine the jurisdiction of this Court vis-a-vis that of the arbitration panel in New York.

Stated briefly, the testimony and evidence presented at the aforementioned hearing disclose that on August 1, 1974, plaintiff opened an individual non-discretionary commodity trading account with defendant Hornblower & Weeks-Hemphill, Noyes, Inc. (Hornblower). Preparatory to opening said trading account, defendant Milne, the commodity account executive representing Hornblower, inquired about plaintiff's trading philosophy, the results of which were recorded in plaintiff's presence on the Hornblower Commodity Questionaire (Def. Ex. 2). Plaintiff therein asserted that although he had no educational background in commodity trading, he had had past experience in the commodity futures market and had just recently closed a similar account with the brokerage firm of Merrill Lynch, Pierce, Fenner & Smith, Inc. He characterized his trading philosophy as "aggressive" and stated his intention to devote as much personal time as possible to his trading activities. He furthermore professed his interest in a high rate of turnover with minimal concern for the attendant risk, and approximated his acceptable total equity loss at 100%. The agreement to open an individual non-discretionary trading account in commodity futures was thereafter reduced to writing, i. e. the Customers Agreement (Def. Ex. 1), which stipulated that the contract would be governed by the laws of the State of New York. The agreement also incorporated the following proviso, designated as paragraph 7:

Controversies which may arise between you and the undersigned shall be determined by arbitration in The City of New York in accordance with the rules of the American Arbitration Association or at the election of the undersigned in accordance with the rules of the Board of Arbitration of the New York Stock Exchange, Inc. The award of any arbitrators appointed pursuant hereto shall be final and judgment upon the award rendered may be entered in any court having jurisdiction. The undersigned on behalf of the undersigned and the executors, administrators, successors and assigns of the undersigned hereby submits to the jurisdiction of such court.

With the signing of the Customer's Agreement, an initial deposit of $25,000 in the form of a personal check was then and there tendered to defendant Milne.

The subsequent trading in the Consolo account, which extended through October, 1974, was of considerable volume. Although plaintiff dealt primarily in sugar futures, he executed a number of transactions for the purchase of corn, wheat, soybean and platinum futures. A recapitulation of the account's activity (Def. Ex. 6) reveals total deposits of $420,500.00; total withdrawals of $255,000.00; total trade profits of $424,104.80; total trade losses of $611,227.00; and total charged commissions of $32,169.50; resulting in a debit balance of $53,791.70 at the closing of the account in October, 1974. Upon liquidation of the account and pursuant to paragraph 7 of the Customer's Agreement, defendant Hornblower filed a claim for the outstanding deficit before the American Arbitration Association in New York City.

In pursuit of a stay of the New York arbitration proceeding, plaintiff asserts that paragraph 7 of the Customer's Agreement violates Section 14 of the Securities Act of 1933, 15 U.S.C. § 77n, as well as Section 29(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78cc(a). Section 77n of Title 15, United States Code, provides: "Any condition, stipulation, or provision binding any person acquiring any security to waive compliance with any provision of this subchapter or of the rules and regulations of the Commission shall be void." Section 78cc(a) of Title 15, United States Code, provides: "Any condition, stipulation, or provision binding any person to waive compliance with any provision of this chapter or of any rule or regulation thereunder, or of any rule of an exchange required thereby shall be void."

Defendants do not challenge the principle derived from the foregoing statutory provisions and willingly concede that an agreement to arbitrate disputes arising under the Securities Act of 1933 and the Securities Exchange Act of 1934 is invalid and unenforceable. Indeed, as stated by the Supreme Court of the United States in Wilko v. Swan, 346 U.S. 427, 434-35, 438, 74 S.Ct. 182, 186, 188, 98 L.Ed. 168 (1953):

The words of § 14, ... void any "stipulation" waiving compliance with any "provision" of the Securities Act. This arrangement to arbitrate is a "stipulation," and we think the right to select the judicial forum is the kind of "provision" that cannot be waived under § 14 of the Securities Act.
* * * * * *
Congress has enacted the Securities Act to protect the rights of investors and has forbidden a waiver of any of those rights. Recognizing the advantages that prior agreements for arbitration may provide for the solution of commercial controversies, we decide that the intention of Congress concerning the sale of securities is better carried out by holding invalid such an agreement for arbitration of issues arising under the Act.

However, preliminary to the enforcement of sections 77n and 78cc(a) as a bar to the pending arbitration proceedings, the Court must determine that the investments in issue come within the purview of the Securities Act and the Securities Exchange Act. This point, defendants do not so willingly concede.

The investments made by plaintiff through his trading account with Hornblower are governed by the Securities Act of 1933 and the Securities Exchange Act of 1934 only if the contracts to purchase commodity futures in which plaintiff traded may be properly defined as "securities" pursuant to both Acts.1 Of the several definitions of the term "security" provided therein, the only definition reasonably applicable to the investments under consideration is that of "investment contract." The Court must therefore determine if a commodity future contract is in fact an "investment contract" and thereby a "security" subject to the regulation of the Securities Act and the Securities Exchange Act. Relevant case authority is emphatically negative.

Upon initial inquiry, the Court observes the general rule that contracts to purchase commodity futures are not investment contracts within the meaning of the federal securities laws and hence, are not securities. Milnarik v. M-S Commodities, Inc., 457 F.2d 274 (7th Cir.), cert. denied, 409 U.S. 887, 93 S.Ct. 113, 34 L.Ed.2d 144 (1972); E. F. Hutton & Co., Inc. v. Burkholder, 413 F.Supp. 852 (D.D.C.1976); Jenson v. Continental Financial Corp., 404 F.Supp. 792 (D.Minn.1975); Glazer v. National Commodity Research and Statistical Services, Inc., 388 F.Supp. 1341 (N.D.Ill.1974); Golding v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 385 F.Supp. 1182 (S.D.N.Y.1974); Arnold v. Bache & Co., Inc., 377 F.Supp. 61 (M.D.Pa. 1973); McCurnin v. Kohlmeyer & Co., 340 F.Supp. 1338 (E.D.La.1972), aff'd, 477 F.2d 113 (5th Cir. 1973); Sinva v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 253 F.Supp. 359 (S.D.N.Y.1966); see Glen-Arden Commodities, Inc. v. Constantino, 493 F.2d 1027 (2d Cir. 1974). The Court is reminded, however, that "in searching for the meaning and scope of the word `security' in the Act, form should be disregarded for substance and the emphasis should be on economic reality." Tcherepnin v. Knight, 389 U.S. 332, 336, 88 S.Ct. 548, 553, 19 L.Ed.2d 564 (1967); see United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 95 S.Ct. 2051, 44 L.Ed.2d 621 (1975); Nash & Associates, Inc. v. Lum's of Ohio, Inc., 484 F.2d 392 (6th Cir. 1973).

The Supreme Court fathomed the definition of the term "investment contract" in its landmark opinion in Securities and Exchange Commission v. W. J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946). Therein the Court, through Justice Murphy, stated:

An investment contract for purposes of
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