Buttrey v. Merrill Lynch, Pierce, Fenner & Smith, Inc.

• Decision Date: 17 April 1969
• Docket Number: No. 17136.,17136.
• Citation: 410 F.2d 135
• Parties: Donald W. BUTTREY, Trustee in Bankruptcy for Dobich Securities Corporation, Plaintiff-Appellee, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., Defendant-Appellant.
• Court: U.S. Court of Appeals — Seventh Circuit

410 F.2d 135 (1969)

Donald W. BUTTREY, Trustee in Bankruptcy for Dobich Securities Corporation, Plaintiff-Appellee, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., Defendant-Appellant.

No. 17136.

United States Court of Appeals Seventh Circuit.

April 17, 1969.

James A. McDermott, Thomas M. Scanlon, Alan W. Boyd, Indianapolis, Ind., for defendant-appellant, Barnes, Hickam, Pantzer & Boyd, Indianapolis, Ind., of counsel.

Frank M. McHale, William F. Welch, John I. Bradshaw, Jr., Alan I. Klineman, James M. Klineman, Indianapolis, Ind., for plaintiff-appellee, McHale, Cook & Welch, Indianapolis, Ind., Klineman, Rose & Wolf, Indianapolis, Ind., of counsel.

Before CASTLE, Chief Judge, and SWYGERT and CUMMINGS, Circuit Judges.

CUMMINGS, Circuit Judge.

This appeal under 28 U.S.C. § 1292(b) involves the question whether defendant was entitled to summary judgment with respect to Counts I, II and III of the complaint. We approve of the district court's action in overruling the defendant's motion for summary judgment.

Plaintiff is the trustee in bankruptcy for Dobich Securities Corporation ("the bankrupt") which had engaged in the sale of securities as a dealer licensed by the State of Indiana. The bankrupt was organized in October 1963 by Michael Dobich, an individual broker-dealer who was then allegedly insolvent. Defendant Merrill Lynch, Pierce, Fenner & Smith, Inc. is a well-known, nation-wide securities dealer and maintains an office in Indianapolis.

According to Count I of the complaint, in December 1963, defendant granted Michael Dobich's request to open a cash account in Indianapolis in the bankrupt's name for the purpose of trading in securities, and Michael Dobich thereafter began to purchase and sell securities in this account. Count I alleges that defendant knew that Michael Dobich was using fraudulently converted property of various customers of the bankrupt in the relevant security transactions with defendant. In its dealings with the bankrupt, defendant assertedly violated Rule 405, the "Know Your Customer Rule" or "The Rule of Due Diligence," of the New York Stock Exchange adopted pursuant to Section 6 of the Securities and Exchange Act of 1934 (15 U.S.C. § 78f), supposedly causing a net loss to the bankrupt of $460,000 plus $55,000 plus in commissions paid, or a total of $515,000.

Count II was based on the same factual allegations and alleged that the "natural result of such course of business by the defendant operated as a fraud or deceit" upon the bankrupt in violation of Section 17 of the Securities Act of 1933 (15 U.S. C. § 77q) and Rule 10b-5 of the Securities and Exchange Commission (17 C.F.R. § 240.10b-5) promulgated under Section 10 of the Securities and Exchange Act of 1934 (15 U.S.C. § 78j).

Count III claimed that defendant knowingly aided, abetted and assisted Michael Dobich in violation of Section 17 of the Securities Act of 1933 and SEC Rule 10b-5. Counts II and III also sought the recovery of $515,000.

As the district court noted, in these three counts plaintiff is asserting creditors' rights to avoid corporate transactions between the bankrupt and defendant. He is seeking to recover net transfers to defendant by the bankrupt in fraud of its customers. Defendant counters that only the customers of the bankrupt can file actions of this type. However, the district court concluded that the bankruptcy trustee was the proper party to prosecute the alleged causes of action, and that each of these counts adequately states a claim. Therefore, summary judgment was denied to defendant.

Authority of Bankruptcy Trustee to Sue

The trustee in bankruptcy is attempting to avoid the bankrupt's transfers to defendant on the ground that they were fraudulent or voidable under Federal law as to the bankrupt's creditors. This theory is supported by Section 70e of the Bankruptcy Act, providing in part as follows (11 U.S.C. § 110(e)):

"(1) A transfer made or suffered or obligation incurred by a debtor adjudged a bankrupt under this title which, under any Federal or State law applicable thereto, is fraudulent as against or voidable for any other reason by any creditor of the debtor, having a claim provable under this title, shall be null and void as against the trustee of such debtor.

"(2) All property of the debtor affected by any such transfer shall be and remain a part of his assets and estate, discharged and released from such transfer and shall pass to, and every such transfer or obligation shall be avoided by, the trustee for the benefit of the estate: Provided, however, That the court may on due notice order such transfer or obligation to be preserved for the benefit of the estate and in such event the trustee shall succeed to and may enforce the rights of such transferee or obligee. The trustee shall reclaim and recover such property or collect its value from and avoid such transfer or obligation against whoever may hold or have received it, except a person as to whom the transfer or obligation specified in paragraph (1) of this subdivision is valid under applicable Federal or State laws."

The transfers which the trustee is attempting to set aside are the bankrupt's payments to defendant from funds belonging to the bankrupt's customers and which had been unlawfully converted by the bankrupt to purchase securities for its own account. The trustee is not seeking to recover the full amount of the claims of the bankrupt's customers but only the net amount of the transfers by the bankrupt to defendant. By virtue of Section 70e(1), if under Federal law these transfers were "fraudulent as against or voidable * * * by any creditor" of the bankrupt, Section 70e(2) empowers the trustee to avoid the transfers "irrespective of the existence of such a cause of action in the bankrupt."¹ 3 Remington on Bankruptcy § 1587 (Rev. ed. 1957).

Although Section 70 of the Bankruptcy Act was the principal basis for the district court's decision that the bankruptcy trustee could prosecute this action, its decision is also supported by Section 60e of the Act. Subparagraph (2) of that Section establishes a fund consisting of the proceeds of a bankrupt stockbroker's customers' property unlawfully converted by the stockbroker. In turn, subparagraph (5) of Section 60e provides in part (11 U.S.C. § 96(e) (5)):

"Where such single and separate fund is not sufficient to pay in full the claims of such single and separate class of creditors, a transfer by a stockbroker of any property which, except for such transfer, would have been a part of such fund may be recovered by the trustee for the benefit of such fund, if such transfer is voidable or void under the provisions of this title. For the purpose of such recovery, the property so transferred shall be deemed to have been the property of the stockbroker and, if such transfer was made to a customer for his benefit, such customer shall be deemed to have been a creditor, the laws of any State to the contrary notwithstanding. * * *"

It should be noted that this provision specifically empowers the trustee to recover the property transferred by the bankrupt stockbroker "if such transfer is voidable or void under the provisions of this title." As we have already seen, Section 70e declares this transfer voidable if contrary to Federal law, as alleged here.²

In opposition to the foregoing interpretation, the defendant relies principally on Barnes v. Schatzkin, 215 App.Div. 10, 212 N.Y.S. 536 (1925), affirmed, 242 N.Y. 552, 152 N.E. 424 (1926), certiorari denied, 273 U.S. 709, 47 S.Ct. 100, 71 L.Ed. 852. There a "bucket shop" brokerage firm converted its customers' funds by purchasing securities for its own account from defendants, members of the New York Stock Exchange, who allegedly had knowledge of the fraudulent conversions. Upon the bankruptcy of the brokerage firm, its customers assigned to the bankruptcy trustee their claims against the defendants as aiders and abetters of the bankrupt. Although holding that the trustee was without legal capacity to maintain the action on the assignments,³ the court noted that Section 70 of the Bankruptcy Act does permit a trustee "to recover property * * transferred * * * in fraud of creditors, or the like" (at 212 N.Y.S. 539). In Barnes, it appears that the trustee was attempting to recover the full amount of the claims of the customers as their assignee, whereas here the bankruptcy trustee is seeking to recover on the theory that there was a fraudulent transfer made by the bankrupt to the defendant, entitling the trustee to recover the net amount of those transfers.

To support its conclusion in Barnes, the court insisted that a debtor-creditor relationship must exist between the transferee and the bankrupt, but it is now settled that such a relationship is not required. Pettit v. American Stock Exchange, 217 F.Supp. 21 (S.D.N.Y. 1963).

In Barnes, the court also observed that the bankrupt could not recover because it was responsible for the illegal transaction. Not only was this view rejected in the Pettit case, but also in Schneider v. O'Neill, 243 F.2d 914 (8th Cir. 1957), where the court observed (at p. 918):

"While it is unquestionably true that the trustee stood in the shoes of the bankrupt, it is equally true that he stood in the overshoes of the creditors * * *."

There it was held that under Section 70e, the trustee has rights and powers on behalf of creditors that are unaffected by the fact that he could not have recovered if he stood only in the shoes of the bankrupt. Even the defendant's reply brief concedes that under Section 70e a trustee is vested with the rights of creditors and is not limited to the rights of the bankrupt. See Globe Bank & Trust Co. v. Martin, 236 U.S. 288, 297, 35 S.Ct. 377, 59 L.Ed. 583; 4A Collier on Bankruptcy ¶ 70.71 at p. 786 (14th ed. 1967); 3 Remington on Bankruptcy § 1587 note 13.1 (1968 Supp.).

In our view, the Barnes case did not face and reject the transfer theory urged here. It was decided...