Edwards & Hanly v. Wells Fargo Sec. Clearance

• Decision Date: 04 October 1978
• Docket Number: No. 75 Civ. 4566.,75 Civ. 4566.
• Citation: 458 F. Supp. 1110
• Parties: EDWARDS & HANLY, Plaintiff, v. WELLS FARGO SECURITIES CLEARANCE CORP., Defendant.
• Court: U.S. District Court — Southern District of New York

458 F. Supp. 1110

EDWARDS & HANLY, Plaintiff, v. WELLS FARGO SECURITIES CLEARANCE CORP., Defendant.

No. 75 Civ. 4566.

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

October 4, 1978.

COPYRIGHT MATERIAL OMITTED

Delson & Gordon, New York City, for plaintiff; Evan L. Gordon, New York City, of counsel.

Milbank, Tweed, Hadley & McCloy, New York City, Sheppard, Mullin, Richter & Hampton, Los Angeles, Cal., for defendant; William A. Masterson, John D. Hussey, Los Angeles, Cal., Eugene F. Farabaugh, New York City, of counsel.

OPINION

GAGLIARDI, District Judge.

Plaintiff Edwards & Hanly commenced this action against the Wells Fargo Securities Clearance Corporation ("WFSCC") alleging violations of § 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b), § 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q, and common law fraud. Jurisdiction is predicated upon 15 U.S.C. §§ 78aa, 77v and principles of pendent jurisdiction. This action was tried to the court, and the following constitutes its findings of facts and conclusions of law pursuant to Rule 52(a), Fed.R. Civ.P. The court determines that plaintiff has proved all the elements of a § 10(b) cause of action and is entitled to recover its damages.

Statement of Facts

Edwards & Hanly is a New York limited partnership engaged in the business of investment banking and a registered broker-dealer of securities pursuant to § 15 of the Exchange Act, 15 U.S.C. § 78o. Defendant WFSCC, an Arizona corporation with its principal place of business in New York, is a wholly-owned subsidiary of Wells Fargo & Company, a holding company among whose subsidiaries is Wells Fargo Bank, N.A. ("WFB"). WFSCC was organized in 1970 to serve as WFB's New York clearing agent for securities transactions involving WFB's clients.

In 1974, Edwards & Hanly acquired the Huntington, New York office of duPont, Walston & Co., including the account of a customer named T. P. Richardson & Co. ("Richardson"). Richardson was a registered broker-dealer, based in Los Angeles, which specialized as an institutional broker in the so-called "third market," i. e., the over-the-counter market in securities listed on the major stock exchanges. (Testimony of Richard Gulemi, Tr. 189 and Stipulation of Facts, ¶¶ 2, 5). Richardson employed approximately fifteen traders who would match buy and sell orders of large blocks of listed stocks made by large financial institutions (e. g., banks, mutual funds, insurance companies and universities), without using the facilities of a national securities exchange. (Stipulation of Facts ¶ 5). Richardson made a profit equal to the difference between the price at which it purchased stock from the seller and the price at which it sold the stock to the buyer on the matched trade. (Id. ¶ 6). Although its traders were generally able to match buy and sell orders exactly, Richardson would at times effect an unmatched trade in order to accommodate one of its institutional clients. (Id., ¶ 7). For example, if such a client wished to sell 10,000 shares of a given stock issue, Richardson would purchase the shares even though it may have been able to find buyers for only 9,000 shares. Richardson would thus buy for its own account and risk, i. e., take a "long" position, 1,000 shares of stock to effect the trade. Conversely, Richardson may have found a buyer of 10,000 shares but sellers for only 9,000. To effect this trade, it would commit to deliver all 10,000 shares to the buyer and take a 1,000 share "short" position for its own account. Richardson's announced business policy was not to maintain positions, short or long, to protect its capital from market fluctuations. To eliminate these positions, Richardson would use the services of stock brokerage firms who were members of the New York Stock Exchange, including Edwards & Hanly, through whom Richardson would, as quickly as possible, sell its long positions or buy stock to cover its short positions. (Id.).

From February, 1974 through April 15, 1975, Richardson maintained a cash brokerage account with Edwards & Hanly on a delivery versus payment, receipt versus payment basis. (Gulemi, Tr. 189). The account both purchased and sold securities, primarily "blue chip" and "glamour" stocks listed on the New York Stock Exchange. The orders were regularly telephoned by Richardson's traders to Dominic Gulemi of Edwards & Hanly's Huntington office. (Id., Tr. 184). Edwards & Hanly's role was solely to execute the orders called in; advice was neither sought nor received from Edwards & Hanly personnel concerning any of the trades in question. The Richardson account was the largest account in plaintiff's Huntington office (O'Hare, Tr. 270), constituting 10-20% of its business (Gulemi, Tr. 217).

In 1973, in order to clear its third market trades, Richardson & Co. established a $10,000,000 secured internal guidance draft line with WFB in Los Angeles. (Stipulation of Facts, ¶ 12). Under this draft line, WFB advanced funds for Richardson's account to a seller of securities bought by Richardson and the certificates would then be delivered to Richardson's buyer against payment of the purchase price. WFB collected interest from the time that it advanced funds for the Richardson account until it collected the purchase price from the buyer. (Id.) In clearing these trades for Richardson, WFB utilized WFSCC as its agent to handle the receipt and delivery of cash and securities in New York. (Id.; ¶ 14). At the end of each trading day, Richardson sent instructions by messenger to WFB in Los Angeles with respect to that day's matched trades on behalf of its institutional customers. WFB received from Richardson confirmation slips for both the buy and sell sides of the trade. (Bowman, Tr. 413). These instructions were then placed on bank forms by WFB's clerical personnel and forwarded by air to WFSCC in New York so that WFSCC received instructions on both sides of the trade simultaneously (Id.).

In a matched trade, Richardson would instruct the seller to deliver the stock to WFSCC. (Stipulation of Facts ¶ 17). Upon receipt of the stock from the seller, WFSCC would pay the seller with funds advanced to WFSCC by WFB from Richardson's draft line of credit. The stock served as collateral to WFB and WFSCC for the advance. WFSCC then notified the buyer that the stock was in its possession and, in most instances, the buyer delivered a check to WFSCC and it delivered the stock to the buyer that same day. (Id.)

WFSCC did not have the authority to clear any trades for Richardson without first receiving instructions from WFB. (Id.; ¶ 16). WFSCC's personnel, however, were permitted to contact Richardson on an informal basis if, because of the time differential between New York and Los Angeles, an early delivery of securities was made to WFSCC for which it had no instructions. (Werba, Tr. 36, 56; Holroyde, Tr. 440-41). Nevertheless, WFSCC was not to act on any informal instructions but was required to await confirmatory instructions from WFB (Id., Tr. 56-57).

In the summer of 1974, Richardson fell behind in its payments to WFB of interest and service charges and WFB suspended clearing for the account (Holroyde, Tr. 436). Clearing services were resumed after Richardson and WFB entered into an agreement which required, inter alia, that Richardson maintain a $150,000 compensating balance in its commercial account with WFB. (Bowman, Tr. 417 & Plaintiff's Exhibit 9). Richardson's subsequent failure to meet some of the conditions set forth in the agreement prompted WFB to demand, in December 1974, that Richardson meet even more stringent conditions, including the maintenance of a $200,000 compensating balance in its account (Bowman, Tr. 418, & Exhibit 10). Richardson met these new requirements and clearing services were continued by WFB (Holroyde, Tr. 437).

Unbeknownst to WFB, early in 1974, at the direction of its president and majority shareholder Thomas P. Richardson, Richardson began to deviate from its regular practice of matching buy and sell orders and began to speculate for its own account. Richardson embarked on a program of making massive short sales of highly volatile "glamour" stocks. (Plaintiff's Exhibit # 5, Stipulation between United States of America and Thomas P. Richardson ¶¶ 25-29). By late 1974, this short-selling comprised a substantial part of Richardson's total business (Kevin Kelley, Tr. 386). In November, 1974, Richardson employees Michael Wawra and Thomas C. Thomas met with the manager of Security Finance Corporation, a stock loan broker, to find stock lenders for Richardson in order to enable it to cover its short positions. (Plaintiff's Exhibit # 5, ¶ 32). Security Finance Corporation soon arranged for several of its clients to lend the securities in their portfolios to Richardson.

Under the terms of the stock loan agreements, lenders were to receive cash payments of not less than 100% of the closing price of the stock on its most recent trading day in exchange for the stock loaned. Such a payment is characterized as the "cash collateral" securing the stock loan. The lender is entitled to retain all profits arising from the use of the cash collateral securing the stock loan as well as all cash and stock dividends paid out by the issuer of the stock. (Id. ¶ 36). In order to keep the amount of cash collateral equal to the market value of the stock loaned, both Richardson and the lenders had reciprocal rights to require adjustments in the collateral called "mark-to-the-market" payments. Thus, if the value of the borrowed stock increased, Richardson would have to make a mark-to-the-market payment to the lender; the converse was also true. (Id.) The cash collateral necessary for Richardson to obtain and maintain these loans was obtained by creating false order tickets and confirmations which showed the stock borrowings to be stock purchases made by Richardson. (Id. ¶ 38). These false documents were attached to the written...