Bennett v. U.S. Trust Co. of New York, 948

• Decision Date: 09 August 1985
• Docket Number: D,No. 948,948
• Citation: 770 F.2d 308
• Parties: Blue Sky L. Rep. P 72,279, Fed. Sec. L. Rep. P 92,250 Richard D. BENNETT and Carole A. Bennett, Plaintiffs-Appellants, v. UNITED STATES TRUST COMPANY OF NEW YORK, Defendant-Appellee. ocket 84-9036.
• Court: U.S. Court of Appeals — Second Circuit

Page 308

770 F.2d 308

Blue Sky L. Rep. P 72,279, Fed. Sec. L. Rep. P 92,250

Richard D. BENNETT and Carole A. Bennett, Plaintiffs-Appellants, v. UNITED STATES TRUST COMPANY OF NEW YORK, Defendant-Appellee.

No. 948, Docket 84-9036.

United States Court of Appeals, Second Circuit.

Argued March 20, 1985.

Decided Aug. 9, 1985.

Edward Brodsky, New York City (Richard P. Swanson, Spengler Carlson Gubar Brodsky & Frischling, New York City, of counsel), for plaintiffs-appellants.

Bernard Cedarbaum, New York City (Elizabeth Richter, Carter, Ledyard & Milburn, New York City, of counsel), for defendant-appellee.

Before MESKILL and PRATT, Circuit Judges, and PALMIERI, ^* District Judge.

MESKILL, Circuit Judge:

This is an appeal from a final judgment of the United States District Court for the Southern District of New York, Duffy, J., dismissing appellants' complaint for failure to state a claim upon which relief could be granted. The complaint alleges causes of action under section 7 of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78g (1982), under section 10(b) of the 1934 Act, 15 U.S.C. Sec. 78j(b) (1982), and rule 10b-5, 17 C.F.R. Sec. 240.10b-5 (1984), under the Racketeer Influenced and Corrupt Organizations Act, 18 U.S.C. Secs. 1961 et seq. (1982) (RICO), under N.Y.Gen.Bus.Law Secs. 352-359g (part of the "Martin Act") and under the common law. The district court granted appellee's Fed.R.Civ.P. 12(b)(6) motion, ruling that no private cause of action exists under section 7 and that there was an insufficient causal connection between appellee's acts and appellants' loss for the remaining claims to state a cause of action. For the reasons that follow, we affirm.

BACKGROUND

This action arises out of a series of loans made between 1977 and 1981 by appellee United States Trust Company of New York (U.S. Trust) to appellants Richard D. and Carole A. Bennett (the Bennetts). The Bennetts used the loan proceeds to purchase public utility stock, depositing the stock with U.S. Trust as collateral. According to the complaint, in making these loans U.S. Trust knowingly or recklessly misrepresented to the Bennetts that the Federal Reserve's margin rules do not apply to public utility stock deposited with a bank as collateral. As a net result of these loans, even though the Bennetts had deposited $1 million in unencumbered public utility stock with U.S. Trust, their account was undermargined.

Eventually, the dividends generated by the public utility stock proved insufficient to cover the interest expenses on the loans, causing the outstanding principal and interest to increase. Concurrently, the market value of the stock decreased and in late 1981 U.S. Trust liquidated the Bennetts' account. At the time of liquidation, the outstanding principal and interest exceeded the stock's market value by $1.2 million. Thus, in addition to the loss of their $1 million in equity, the Bennetts owed U.S. Trust $1.2 million.

The Bennetts commenced this action in April 1984 seeking damages based on the decline in market value of the stock purchased with the loan proceeds and on the interest charged on the loans. The complaint alleges eight causes of action: the first two seek recovery under section 7 and the margin rules, the third seeks recovery for breach of representation, the fourth seeks recovery under section 10(b) and rule 10b-5, the fifth seeks recovery for common law fraud, the sixth seeks recovery under the Martin Act and the seventh and eighth seek recovery under RICO.

U.S. Trust moved to dismiss the complaint pursuant to Fed.R.Civ.P. 12(b)(6) for

failure to state a claim upon which relief could be granted. By Memorandum and Order dated November 26, 1984, the district court granted the motion. It dismissed the two claims brought under the margin rules because it determined that Congress did not intend to create a private cause of action under section 7. It dismissed the remaining claims because it believed that there was an inadequate causal relationship between U.S. Trust's acts and the Bennetts' loss.

DISCUSSION

The Bennetts appeal the entire ruling made below, asserting that all eight causes of action state grounds for relief. We affirm the judgment of the district court.

I. Federal Claims

A. Section 7

The Bennetts' first two causes of action seek recovery based on U.S. Trust's violation of Regulation U. Regulation U was promulgated by the Federal Reserve pursuant to section 7 of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78g (1982). Section 221.1(a)(1) of Regulation U, as it existed at the time of the loans, provided, in pertinent part:

[N]o bank shall extend any credit secured directly or indirectly by any margin stock for the purpose of purchasing or carrying any margin stock in an amount exceeding the maximum loan value of the collateral, as prescribed from time to time.

12 C.F.R. Sec. 221.1(a)(1) (1983). According to the Bennetts, an innocent, good faith investor has a private right of action against a bank that violates Regulation U.

Neither section 7 nor Regulation U expressly provide for a private cause of action. Nevertheless, in Pearlstein v. Scudder & German, 429 F.2d 1136 (2d Cir.1970), cert. denied, 401 U.S. 1013, 91 S.Ct. 1250, 28 L.Ed.2d 550 (1971) (Pearlstein I ), a divided panel of this Court held that a private cause of action exists for violations of section 7. Since our decision in Pearlstein I, however, there have been two developments that directly affect this issue. First, section 7 was amended and a new subsection f was added. Pub.L. No. 91-508, Title III, Sec. 301(a), 84 Stat. 1114, 1124 (1970) (codified at 15 U.S.C. Sec. 78g(f) (1982)). Prior to the enactment of subsection f it was only unlawful to extend credit in violation of the margin rules. Subsection f makes it also unlawful to accept credit in violation of those rules. We have previously recognized that the addition of subsection f "cast[s] doubt on the continued viability of the rationale" of Pearlstein I. Pearlstein v. Scudder & German, 527 F.2d 1141, 1145 n. 3 (2d Cir.1975) (Pearlstein II ).

Second, in the years since Pearlstein I was decided, the Supreme Court has altered its method of analyzing claims of implied causes of action. In Cort v. Ash, 422 U.S. 66, 95 S.Ct. 2080, 45 L.Ed.2d 26 (1975), the Court listed four criteria that should be considered when determining if an implied cause of action exists: (1) whether "the plaintiff [is] 'one of the class for whose especial benefit the statute was enacted,' " (2) whether there is "any indication of legislative intent, explicit or implicit, either to create such a remedy or to deny one," (3) whether it is "consistent with the underlying purposes of the legislative scheme to imply such a remedy," and (4) whether "the cause of action [is] one traditionally relegated to state law ... so that it would be inappropriate to infer a cause of action based solely on federal law." 422 U.S. at 78, 95 S.Ct. at 2088 (quoting Texas & Pacific Ry. Co. v. Rigsby, 241 U.S. 33, 39, 36 S.Ct. 482, 484, 60 L.Ed. 874 (1916)). Although early post-Cort decisions treated each of these four factors as independent tests, subsequent Supreme Court decisions have indicated that they should not be so treated. Thus, while these factors remain relevant, the central inquiry must be whether Congress intended to create a private cause of action. See, e.g., Daily Income Fund v. Fox, 464 U.S. 523, ----, 104 S.Ct. 831, 838, 78 L.Ed.2d 645 (1984); Merrill Lynch, Pierce, Fenner & Smith v. Curran, 456 U.S. 353, 377-78, 102 S.Ct 1825, 1838-39, 72 L.Ed.2d 182 (1982); see also Schrachta v. Curtis, 752 F.2d 1257, 1258-59 (7th Cir.1985).

In the wake of these two developments, district courts in this Circuit are split over whether Pearlstein I remains good law. Compare Panayotopulas v. Chemical Bank, 464 F.Supp. 199, 201-03 (S.D.N.Y.1979) (private cause of action exists under section 7 for bank's violation of Regulation U); Palmer v. Thomson & McKinnon Auchincloss, Inc., 427 F.Supp. 915, 919-22 (D.Conn.1977) (private cause of action exists under section 7 for broker's violation of Regulation T), with Schy v. FDIC, 465 F.Supp. 766, 770-75 (E.D.N.Y.1977) (no private cause of action exists under section 7 for bank's violation of Regulation U); Establissement Tomis v. Shearson Hayden Stone, Inc., 459 F.Supp. 1355, 1358-60 (S.D.N.Y.1978) (no private cause of action exists under section 7 for broker's violation of Regulation T).

There is no conflict, however, among the circuit courts that have recently considered this issue. All five that have decided the question have held that no private cause of action exists under section 7. Bassler v. Central National Bank, 715 F.2d 308, 310-13 (7th Cir.1983); Walck v. American Stock Exchange, 687 F.2d 778, 788-89 (3d Cir.1982), cert. denied, 461 U.S. 942, 103 S.Ct. 2118, 77 L.Ed.2d 1300 (1983); Gilman v. FDIC, 660 F.2d 688, 691-93 (6th Cir.1981); Gutter v. Merrill Lynch, Pierce, Fenner & Smith, 644 F.2d 1194, 1197-99 (6th Cir.1981), cert. denied, 455 U.S. 909, 102 S.Ct. 1256, 71 L.Ed.2d 447 (1982); Stern v. Merrill Lynch, Pierce, Fenner & Smith, 603 F.2d 1073, 1074-93 (4th Cir.1979); Utah State University v. Bear, Stearns & Co., 549 F.2d 164, 169-70 (10th Cir.), cert. denied, 434 U.S. 890, 98 S.Ct. 264, 54 L.Ed.2d 176 (1977).

We agree and hold that no private right of action exists under section 7. First, as the above decisions recognize, there is simply no evidence that in passing section 7 Congress intended to create a private cause of action. Bassler, 715 F.2d at 313 ("there is no indication of legislative intent, explicit or implicit, to create a private right of action"); Walck, 687 F.2d at 789 (there is "no significant evidence of congressional intent to imply a remedy in Sec. 7;" presence of express remedies in other sections of 1934 Act raises inference that absence of express remedy under section 7 was purposeful); Gilman, 660 F.2d at 692 ("The language and...