Colonial Sec., Inc. v. MERRILL LYNCH, PIERCE & SMITH INC.

• Decision Date: 13 December 1978
• Docket Number: No. 77 Civ. 1014.,77 Civ. 1014.
• Citation: 461 F. Supp. 1159
• Parties: COLONIAL SECURITIES, INC. and Pasquale Catizone, Plaintiffs, and Neuberger Securities Corp., Intervenor-Plaintiff, v. MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED, Defendant, Carl Hornung et al., Additional Defendants on Counterclaim.
• Court: U.S. District Court — Southern District of New York

461 F. Supp. 1159

COLONIAL SECURITIES, INC. and Pasquale Catizone, Plaintiffs, and Neuberger Securities Corp., Intervenor-Plaintiff, v. MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED, Defendant, Carl Hornung et al., Additional Defendants on Counterclaim.

No. 77 Civ. 1014.

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

December 13, 1978.

COPYRIGHT MATERIAL OMITTED

Gusrae, Greene & Kaplan, New York City, for plaintiffs; Bert L. Gusrae, New York City, of counsel.

Lefrak, Fischer, Myerson & Mandell, New York City, for intervenor-plaintiff; Sander Marc Rabin, Edward R. Mandell, New York City, of counsel.

Brown, Wood, Ivey, Mitchell & Petty, New York City, for defendant Merrill Lynch, Pierce, Fenner & Smith Inc., Roger J. Hawke, Thomas J. Mullaney, New York City, of counsel.

Schwenke & Devine, New York City, for additional defendants; Richard W. Lyon, New York City, of counsel.

OPINION

ROBERT J. WARD, District Judge.

Plaintiffs, Colonial Securities, Inc. ("Colonial") and Pasquale Catizone ("Catizone") bring this action to recover damages resulting from two transactions involving stock delivered to defendant Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch") on January 21, 1977 ("the Amdahl transaction") and on February 24, 1977 ("the Kirby transaction"). Defendant Merrill Lynch has asserted a counterclaim against plaintiffs and additional defendants Carl Hornung and Joseph Ward ("Ward") d/b/a J&S Farms, to recover damages resulting from a third transaction ("the Polaroid transaction"). The action was tried before the Court without a jury. For the reasons hereinafter stated, plaintiffs' claims are dismissed and defendant Merrill Lynch is awarded judgment on its counterclaim.

I The Parties

Plaintiff Colonial, a New Jersey corporation, with its principal place of business at One Exchange Place, Jersey City, New Jersey, is registered with the Securities and Exchange Commission ("Commission") and the National Association of Securities Dealers ("N.A.S.D.") as a broker and dealer of securities. Plaintiff Catizone, a New Jersey resident, is present of Colonial. Intervenor-plaintiff Neuberger Securities Corp. ("Neuberger") is registered with the Commission and the N.A.S.D. as a broker and dealer of securities. Neuberger has purportedly assigned its claim against Merrill Lynch in the present action to Colonial.

Defendant Merrill Lynch, a Delaware corporation with its principal place of business at One Liberty Plaza, New York, New York, is also registered with the Commission and the N.A.S.D. as a broker and dealer of securities. Additional defendant Carl Hornung, a New York resident, managed accounts at Colonial and Merrill Lynch in the name of J&S Farms. Additional defendant Ward, a New York resident, contributed the capital for the J&S Farms accounts managed by Carl Hornung. Additional defendant Paul Hornung, a New York resident and brother of Carl Hornung, was at all relevant times a partner in New Hampshire Capital Co. ("New Hampshire") and the principal shareholder of Exeter Capital Fund, Inc. ("Exeter"), which had accounts at both Colonial and Merrill Lynch.

II The Kirby Transaction

Prior to January 21, 1977, defendant Paul Hornung, acting through New Hampshire and Exeter, sold short a total of 10,200 shares of Kirby Exploration Co. ("Kirby") common stock in two special cash accounts at Merrill Lynch for settlement on or before January 21, 1977. Although the New Hampshire and Exeter accounts were nominally separate, Paul Hornung commingled funds between the two accounts and treated them as one. By February 23, 1977, more than a month after the settlement date, none of the 10,200 shares of Kirby had been delivered to Merrill Lynch. On that date, Merrill Lynch bought in 6,200 shares of Kirby for the account of Exeter. As a result of this purchase, and the buy-in of other stock, a debit balance was created in the Exeter account.

On February 24, 1977 Colonial delivered to Merrill Lynch certificates for 1,500 shares of Kirby which it had obtained from Neuberger earlier that day. The delivery bills accompanying the certificates stated that 1,100 of the shares were being delivered "for the account of: Exeter Capital Fund against the amount of: $38,198.96" and that 400 of the shares were being delivered "for the account of: New Hampshire Cap. Fund against the amount of: $13,740.53 vs. trade of 1/21/77." In delivering the Kirby stock to Merrill Lynch, Colonial acted at the request of Paul Hornung and as agent for the New Hampshire and Exeter accounts. Neither Colonial nor Catizone had any beneficial interest in either of the accounts.

The 1,500 shares of Kirby which were delivered to Merrill Lynch had been purchased by Paul Hornung in a special cash account maintained in the name of New Hampshire at Colonial. Prior to making payment for the Kirby shares, Paul Hornung instructed Colonial to deliver the stock to Merrill Lynch against payment of the price at which the stock had previously been sold at Merrill Lynch. Colonial was therefore aware that Paul Hornung was planning to sell the stock before payment and that it would be paid for the Kirby stock only from the proceeds of the sale of that stock at Merrill Lynch.

Merrill Lynch, however, upon accepting delivery of the Kirby certificates did not pay cash to Colonial for New Hampshire's account. Instead, it credited the New Hampshire account with the full price at which the 1,500 shares of Kirby stock had been sold.

During the course of these dealings in Kirby stock, Merrill Lynch made no representations to Colonial or Catizone that it would make a cash payment to Colonial for Colonial's own account, nor did it ever suggest to Colonial that it would pay out any more than the credit balance which existed in the New Hampshire and Exeter accounts. Nor did Catizone ever inform Merrill Lynch that New Hampshire and Exeter had accounts at Colonial, that Colonial had any transactions with Paul Hornung in Kirby stock, or that Colonial was ever acting as other than delivery agent for its principals.

After crediting New Hampshire for the 1,500 shares of Kirby received in the New Hampshire account, Merrill Lynch bought in, at a loss, on February 24, 1977, the remaining 2,500 shares of Kirby which were overdue in that account.

As a result of these transactions, there existed on February 24, 1977, a net debit balance in the Exeter account of $4,168.76, a net credit balance in the New Hampshire account of $17,643.55, or an overall net credit balance between the two accounts of $13,474.79. If Merrill Lynch had paid out $51,939.49 in cash for the 1,500 shares of Kirby it received on February 24, 1977, instead of crediting the New Hampshire account in that amount, there would have been an unsecured debit of $38,464.70 in the New Hampshire and Exeter accounts.

III The Amdahl Transaction

Defendant Ward doing business as J&S Farms maintained special cash accounts at the Syracuse and One Liberty Plaza, New York City offices of Merrill Lynch, as well as at other brokerage firms. The capital for the J&S Farms brokerage accounts was contributed by Ward. Carl Hornung was authorized by Ward to manage the accounts and to enter orders for the purchase and sale of securities. However, Merrill Lynch sent account statements directly to Ward.

In December 1976, Ward d/b/a J&S Farms sold short 2,700 shares, 5,400 after a split, of Rovac stock in the Syracuse account. Upon his failure to deliver that stock, Merrill Lynch bought in 5,400 shares for the account of J&S Farms for settlement on January 24 and 26, 1977 at a total cost of $91,960. This buy-in resulted in a debit balance of $36,221.73. On January 21, 1977, Colonial, acting as agent for Ward d/b/a J&S Farms, delivered 1,000 shares of Amdahl stock to Merrill Lynch's New York office against payment of $34,057.50. The delivery was in partial satisfaction of the sale of 3,000 shares of Amdahl which Carl Hornung and Ward d/b/a J&S Farms had previously made at Merrill Lynch in that account.

The 1,000 shares of Amdahl delivered to Merrill Lynch had been purchased by Carl Hornung in a special cash account at Colonial in the name of J&S Farms. The purchase price was $36,586.50. However, neither Carl Hornung nor Joseph Ward d/b/a J&S Farms ever paid Colonial for the stock. Instead, they instructed Colonial to deliver the stock to Merrill Lynch against payment of $34,057.50. The fact that Colonial had not been paid for the Amdahl stock was not disclosed to Merrill Lynch at the time.

The settlement of the Rovac buy-ins had not occurred by January 21, 1977. On that date, Merrill Lynch's New York office believed that the Syracuse account of J&S Farms had sufficient funds to cover the delivery against payment of the 1,000 shares of Amdahl. Accordingly, on January 21, 1977, Merrill Lynch issued a check for $34,057.50 to "Colonial Securities, Inc. a/c J&S Farms." After the settlement of the Rovac buy-ins on January 24th and 26th, Merrill Lynch realized that the J&S Farms account had a credit balance of only $7,025.77, and not in excess of $34,057.50. Upon learning of its mistake, Merrill Lynch stopped payment on its check, advised Carl Hornung and Ward by letter dated January 27, 1977 of the facts and circumstances and offered to issue a check for the sales proceeds of the Amdahl shares upon receipt of a certified check for the cost of the buy-ins.

At the time the Amdahl stock was delivered to Merrill Lynch on January 21, 1977 Colonial was acting as a delivery agent and had no beneficial interest in the J&S Farms account.

IV The Polaroid Transaction

At some time prior to February 4, 1977, Catizone and Carl Hornung agreed that, as a means of repaying the debit balance in the J&S Farms account at Colonial, they would purchase a number of shares in the J&S Farms account at Merrill Lynch, obtain delivery of the stock and stop payment on the check given to Merrill Lynch for the purchase of the stock. They selected 1,000...