Abrams v. Oppenheimer Government Securities, Inc.

• Decision Date: 30 May 1984
• Docket Number: No. 83-1811,83-1811
• Citation: 737 F.2d 582
• Parties: Fed. Sec. L. Rep. P 91,512 Richard N. ABRAMS, Plaintiff-Appellee, v. OPPENHEIMER GOVERNMENT SECURITIES, INC. and James Zurek, Defendants-Appellants.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 582

737 F.2d 582

Fed. Sec. L. Rep. P 91,512

Richard N. ABRAMS, Plaintiff-Appellee, v. OPPENHEIMER GOVERNMENT SECURITIES, INC. and James Zurek Defendants-Appellants.

No. 83-1811.

United States Court of Appeals, Seventh Circuit.

Argued Dec. 6, 1983.

Decided May 30, 1984.

James E. Beckley, James E. Beckley & Assoc., P.C., Chicago, Ill., for defendants-appellants.

Richard W. Hillsberg, Tishler & Wald, Ltd., Chicago, Ill., for plaintiff-appellee.

Before CUMMINGS, Chief Judge, PELL and WOOD, Circuit Judges.

CUMMINGS, Chief Judge.

This interlocutory appeal presents the issue of whether a Government National Mortgage Association ("GNMA") forward contract constitutes the purchase and sale of the underlying GNMA security and therefore is regulated by the antifraud provisions of the securities laws, even though the GNMA forward contract itself is not a security as defined by the securities laws. We affirm the district court's holding that the antifraud provisions apply.

I

On February 6, 1981, plaintiff Richard Abrams entered into an agreement with defendant Oppenheimer Government Securities, Inc. ("OGS"), for the purchase and delivery of approximately $200,000 of GNMA 30-year, 13% interest, mortgage-backed pass-through certificates (also known as Ginnie Maes). Briefly, the program involves, inter alia, the GNMA itself, which is a Government corporation within the Department of Housing and Urban Development, see 12 U.S.C. Secs. 1716 et seq., 24 C.F.R. ch. III, private issuers (primarily mortgage bankers), broker-dealers such as defendant OGS, and investors such as plaintiff. The private institutions issue GNMA certificates which evidence an interest in a pool of Government-underwritten residential mortgages. The holder of a GNMA receives a proportion of the income generated as mortgagors in the pool repay their loans, and the timely payment of principal and interest to the GNMA holder is guaranteed by the Government. GNMA's are considered securities (as well as commodities), and like most securities or commodities are freely transferrable from one investor to another. The main objectives of the program are to increase liquidity in the secondary mortgage market and attract new private sources of funds into residential loans. See Board of Trade of City of Chicago v. S.E.C., 677 F.2d 1137, 1139 (7th Cir.1982), vacated as moot, 459 U.S. 1026, 103 S.Ct. 434, 74 L.Ed.2d 594-595; Dep't of Housing and Urban Development, Analysis And Report On Alternative Approaches To Regulating The Trading Of GNMA Securities, vol. I, at 1-15 (1978) (HUD Report).

The agreement entered into by the parties is known as a forward contract. The trade date is the date the contract here was purchased, February 6, 1981, but the settlement date, i.e., the date upon which plaintiff was to remit the balance of the purchase price in exchange for delivery of the GNMA certificates, is May 20, 1981. Delayed delivery is in part a result of the lead time required by the issuer to effectuate the mortgage loans once the issuer receives assurance of a ready market for the GNMA's. To hedge against the possibility of falling interest rates between the date the issuer makes a firm commitment to a home buyer or builder and the date the securities are actually issued, issuers generally sell GNMA forward contracts to broker-dealers such as defendant OGS, who in turn enter into contracts for forward delivery with investors such as Abrams. Because GNMA's (GNMA "actuals") and GNMA forward contracts are fully transferrable from one investor to another, markets for these instruments have evolved, and their value may vary. Purchasers of GNMA forwards such as plaintiff typically speculate that the value of the GNMA certificates will increase. A myriad of factors can influence the market value of GNMA's. Most notably, as a long-term fixed interest security, outstanding GNMA's will become more attractive comparatively and their value will generally (though not necessarily) rise in the event that the prevailing long-term interest rates fall. In such a situation the purchaser of the forward would take delivery of the GNMA securities with a market value exceeding the purchase price. Another avenue is available: though the purchaser is obligated by the forward contract to take delivery of the GNMA's, he may assign his rights and obligations by selling the contract before the settlement date. ¹ The same alternatives are of course available in the event the market value falls, the deflated value being reflected in the price if the purchaser sells before the settlement date.

From this somewhat simplified background of GNMA's and GNMA forwards we now turn to the transaction at issue. In the agreement negotiated by the parties, plaintiff orally agreed with defendant James Zurek, an employee of OGS, to provide a "good faith" deposit of 10% of the purchase price. Abrams remitted the deposit of $19,200 on March 10, 1981. Plaintiff then received a demand from OGS on or about April 10 for an additional deposit of $9,647 by April 13. According to the demand letter the additional deposit was necessary "due to a decrease in the market value of the GNMA securities." Plaintiff refused to remit the requested funds on the ground that he had not been informed such demands could be made. The very purpose of the original deposit is also in dispute. According to plaintiff, the good faith deposit was to be applied to the balance of the total GNMA purchase price, with the balance due on the settlement date of May 20, 1981. Defendants assert that "the deposit would be returned after the GNMA forward transaction was completed." Defendants' Reply Br. at 1. Defendants also allege in effect the original agreement contemplated that the amount of the deposit returnable to plaintiff could be reduced to compensate OGS for any loss OGS sustained in the transaction. ²

Plaintiff also alleges that Zurek made material misrepresentations in regard to the expected value of the GNMA certificates and their relationship with the prime lending rate. Zurek allegedly represented that the value of a GNMA certificate would increase by six points (i.e., six-hundredths of one percent) for each one point decrease in the prime rate. The origin of this litigation is that while the prime rate declined during the pre-settlement period, so did the market value of the plaintiff's soon-to-be-issued GNMA's, to the extent of approximately seven points since, possibly along with other contributing factors, prevailing long-term interest rates did not fall contemporaneously with the prime rate at this given time. In addition, Zurek, according to plaintiff, told him that "he [Zurek] had never seen the bonds so low and recommended immediate purchase." Plaintiff's Complaint, Count I, par. 9. Finally, plaintiff claims that Zurek told him he would receive 18 1/2% interest on his deposit. Plaintiff claims the deposit accrued interest at a rate of approximately 14 1/2% to 15%.

When plaintiff did not accede to the request for additional funds, OGS sold plaintiff's contract and returned only $1,700 of the deposit, retaining $17,500 on the grounds that plaintiff breached the contract and that the $17,500 fairly compensates OGS for the decrease in the market value of the GNMA securities.

Plaintiff filed a seven-count amended complaint in the district court against defendants Zurek and OGS to recover the $17,500 in dispute. Count I alleges a violation of the Commodity Exchange Act (CEA), 7 U.S.C. Secs. 1 et seq. Counts II and III claim violations of the antifraud provisions of the federal securities laws. Thus Count II alleges violations of Section 17(a) of the Securities Act of 1933 (SA), 15 U.S.C. Sec. 77q(a), and Section 10(b) of the Securities and Exchange Act of 1934 (SEA), 15 U.S.C. Sec. 78j(b). Count III alleges that defendants violated both SEA Section 10(b) and its adjunct, Securities and Exchange Commission (SEC) Rule 10b-5. Counts IV through VII, invoking the court's pendent jurisdiction, claim respectively that defendants violated the Illinois Securities Law of 1953, Ill.Rev.Stat. ch. 121 1/2, Secs. 137.13-137.14, committed common law fraud, acted negligently, and breached their contract with plaintiff.

The defendants moved to dismiss the separate counts on various grounds. Most relevant to this interlocutory appeal are Counts II and III based on the federal securities laws. Defendants argued that the antifraud provisions of the 1933 and 1934 Acts do not apply because a contract to take delivery of a GNMA, i.e., a GNMA forward, is not a security as defined under the Acts. Defendants also alleged that Counts II and III should be dismissed on the ground that Section 17(a) of the 1933 Act, 15 U.S.C. Sec. 77q(a), does not provide plaintiff a private right of action.

In a well-reasoned, unpublished memorandum opinion, Judge Leighton denied defendants' motion to dismiss Counts II and III. The district court acknowledged that GNMA forwards in and of themselves are not securities, but the relevant factual circumstance is that "the parties contracted for the sale of GNMA certificates which are undoubtedly securities." Abrams v. Oppenheimer Government Securities, Inc., No. 82 C 1356, slip op. at 9 (N.D.Ill. Jan. 3, 1982). The antifraud provisions of the securities acts apply to the "purchase" and "sale" of securities, and the court noted that "it is well established that merely contracting to sell securities constitutes a 'purchase' or 'sale' of the underlying securities for purposes of the Securities Acts." Id. at 10 (footnote omitted). The court also rejected defendants' claim that no private right of action lies in favor of plaintiff under Section 17(a) of the 1933 Act. Id. at 12.

The court granted defendants' motion to dismiss only with respect to Count I and in part to Count IV. Regarding Count I, the court noted that the Commodities Exchange Act applies only to commodities transactions which take place on a formally...