Establissement Tomis v. Shearson Hayden Stone

• Decision Date: 08 November 1978
• Docket Number: No. 76 Civ. 5675 (HFW).,76 Civ. 5675 (HFW).
• Citation: 459 F. Supp. 1355
• Parties: ESTABLISSEMENT TOMIS, Plaintiff, v. SHEARSON HAYDEN STONE, INC., and Jeffrey Nash, Defendants, Juanita E. Spiegel and Stanley Spiegel, Additional Defendants on Counterclaim.
• Court: U.S. District Court — Southern District of New York

459 F. Supp. 1355

ESTABLISSEMENT TOMIS, Plaintiff, v. SHEARSON HAYDEN STONE, INC., and Jeffrey Nash, Defendants, Juanita E. Spiegel and Stanley Spiegel, Additional Defendants on Counterclaim.

No. 76 Civ. 5675 (HFW).

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

November 8, 1978.

COPYRIGHT MATERIAL OMITTED

Gusrae, Greene & Kaplan, New York City, for plaintiff Establissement Tomis.

Willkie, Farr & Gallagher, New York City, by Michael B. Targoff, Thomas C. O'Keefe and New York City, Gerald Kerner, for defendants Shearson Hayden Stone, Inc. and Jeffrey Nash.

Chadbourne, Parke, Whiteside & Wolff, New York City, by Chester J. Hinshaw, Terry A. Thompson, New York City, of counsel, for additional defendants Juanita E. Spiegel and Stanley Spiegel.

MEMORANDUM DECISION

WERKER, District Judge.

Plaintiff Establissement Tomis ("Tomis"), a Liechtenstein corporation, commenced this action charging defendants, securities brokerage firm Shearson Hayden Stone, Inc. ("Shearson") and its registered representative Jeffrey Nash ("Nash") with violations of section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b), and Rules 10b-5 and 10b-16 promulgated thereunder, 17 C.F.R. 240.10b-5 and 10b-16; section 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a); section 7(c) of the Exchange Act, 15 U.S.C. § 78g(c), and Regulation T promulgated thereunder by the Federal Reserve Board, 12 C.F.R. 220.1 et seq.; and New York Stock Exchange Rules 431 and 432 in connection with the operations of Tomis' margin account with Shearson.¹ Each cause of action seeks $185,007.88 in damages; Tomis also requests $100,000 in punitive damages. Shearson counterclaimed against Tomis for the debit balance of its account, $96,308.30. Stanley and Juanita Spiegel were added as additional defendants by Shearson on the counterclaim. Stanley Spiegel is apparently the president and general agent of Tomis and executed the option agreement and customer's agreement with Shearson on Tomis' behalf. Juanita Spiegel, his wife, is the owner of Tomis.

Shearson, contending that as a matter of law Tomis possesses no cause of action arising out of margin violations, moves for judgment on the pleadings; the Spiegels move for summary judgment or alternatively for dismissal of the counterclaim against them. Both motions will be determined in this opinion.

The pertinent facts, briefly stated, are as follows. In November of 1973 Tomis opened its account with Shearson and traded in the purchase and sale of options on margin until April of 1975 when Tomis had a short position in the securities of Burroughs Corporation and the Digital Equipment Corporation. It is disputed whether Shearson issued a margin call at this point. Eventually, since the margin deficit was not met, Shearson liquidated the Tomis account and was left with the $96,308.30 debit balance which it presently seeks to recover.

The Motions of Shearson and Nash

I. Second Cause of Action²

Tomis' second cause of action alleges violations of section 7(c) of the Exchange Act³ and Regulation T⁴ promulgated thereunder. Tomis claims that defendants' failure to satisfy margin requirements along with the failure to notify Tomis of the status of its account resulted in numerous trading transactions causing financial loss that would not have occurred otherwise. Defendants respond that section 7 and Regulation T do not support a private right of action.

The starting point is the Second Circuit's decision 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") where the court found an implied right of action under section 7 and Regulation T in favor of a customer against a broker for violations of margin requirements. The court stated that although the legislative history of section 7 indicated that "protection of individual investors was a purpose only incidental to the protection of the overall economy from excessive speculations," id. at 1140, nevertheless private suits by investors serve as "a highly effective means of protecting the economy as a whole from margin violations by brokers and dealers." Id. Judge Friendly dissented, voting to deny recovery based upon an implied right of action. Subsequent to "Pearlstein I" section 7(f)⁵ of the Exchange Act was enacted in 1970 and implemented by Regulation X, 12 C.F.R. § 224, et seq.⁶ Section 7(f) makes it unlawful for any person to receive, obtain or enjoy any illegal extension of credit, thereby placing a duty upon the investor himself to comply with margin requirements. As noted recently in Nussbacher v. Chase Manhattan Bank, 1977-78 Transfer Binder Fed.Sec.L.Rep. (CCH) ¶ 96,254 at 92,692 (S.D.N.Y.1977), rev'd on rehearing, 444 F.Supp. 973 (S.D.N.Y.1978), no such customer accountability existed when "Pearlstein I" was decided. Rather, at that time only the broker was liable for a section 7 violation. And, as noted in Schy v. FDIC, 1977-78 Transfer Binder Fed.Sec.L.Rep. (CCH) ¶ 96,242 (E.D.N.Y.1977), appeal pending, the amendment to section 7 "prompted widespread reanalysis of Pearlstein I principles" even within the Second Circuit itself. Id. at 92,629. Thus in Pearlstein v. Scudder & German, 527 F.2d 1141 (2d Cir. 1975) ("Pearlstein II") the court recognized that the enactment of section 7(f) and the promulgation of Regulation X "cast doubt on the continued viability of the rationale of our prior holding." 527 F.2d at 1145 n.3 (2d Cir. 1975) (citation omitted).

Cases subsequent to "Pearlstein I and II" have incorporated the analysis of Cort v. Ash, 422 U.S. 66, 95 S.Ct. 2080, 45 L.Ed.2d 26 (1975), in determining whether an implied cause of action exists under section 7. See, e. g., Nussbacher v. Chase Manhattan Bank, supra; Schy v. FDIC, supra; Drasner v. Thomson McKinnon Securities, Inc., 433 F.Supp. 485, 498-501 (S.D.N.Y.1977); Theoharous v. Bache & Co., 1977-78 Transfer Binder Fed.Sec.L.Rep. (CCH) ¶ 96,281 (D.Conn.1977); Stern v. Merrill Lynch, Pierce, Fenner and Smith, Inc., Current Fed.Sec.L.Rep. (CCH) ¶ 96,528 (D.Ma.1978). Specifically, the Cort v. Ash criteria applied in these cases has been:

"First, is the plaintiff `one of the class for those especial benefit the statute was enacted.' . . . that is, does the statute create a federal right in favor of the plaintiff? Second, is there any indication of legislative intent, explicit or implicit, either to create such a remedy or to deny one? . . . Third, is it consistent with the underlying purposes of the legislative scheme to imply such a remedy for the plaintiff? And finally, is the cause of action one traditionally relegated to state law, in an area basically the concern of the States, 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 (citations omitted). Upon consideration of these factors the above courts have determined that the time has come to part with the Pearlstein rationale.

Turning to the first of the Cort factors, there is no dispute that the investor is merely an incidental beneficiary of section 7 rather than one for whose "especial benefit" the section was enacted. Such a position was even voiced by the "Pearlstein I" court where it noted that legislative history shows that protection of the economy from excessive speculation rather than protection of investors is the main purpose of section 7. 429 F.2d at 1140, citing Report of the House Committee on Interstate & Foreign Commerce, H.R. Rep. No. 1383, 73d Cong., 2d Sess. 8 (1934). Legislative history is, however, neutral as to the second Cort factor, and both the Schy and Theoharous courts have expressly interpreted congressional silence concerning the creation of a remedy as an implied denial of a private cause of action. Schy, ¶ 96,242 at 92,630; Theoharous, ¶ 96,281 at 92,802. In so doing, Chief Judge Mishler noted in Schy that the statutory scheme, including Federal Reserve Board regulation and SEC enforcement through administrative and penal sanctions, provided a means of "public oversight" of margin violations. Accord, Drasner v. Thomson McKinnon Securities, Inc., 433 F.Supp. at 501. As to the third Cort factor, there appears to be sufficient reason to find the implication of a private remedy inconsistent with the legislative scheme since it is the whole scale economy rather than the investor that section 7 and Regulation T seek to protect. A private right of action would undoubtedly benefit the individual investor but it would leave the overall economic system unaffected. See Theoharous, ¶ 96,281 at 92,802. As the Schy, Drasner and Stern courts aptly pointed out, a private right of action may foster margin violations by encouraging an investor to consent to violations and avoid SEC enforcement proceedings if financial success results while providing him with a "fall back" position in the form of a suit against the broker when he loses. See also "Pearlstein I," 429 F.2d at 1148-49 (Friendly, J., dissenting).⁷ This, coupled with the investor's status as only an incidental beneficiary of section 7 and Regulation T, leads this court to agree with those who have concluded that a private right of action is not a "necessary supplement" to administrative enforcement of margin restrictions. See Piper v. Chris-Craft, 430 U.S. 1, 25, 97 S.Ct. 926, 51 L.Ed.2d 124 (1977) (Court noted that where there is congressional silence as to remedies under the Exchange Act, a private right of action may be implied for a particular class whom the statute seeks to protect where congressional purposes would be undermined without private enforcement). In so concluding I decline to follow those cases in this circuit which continue to recognize the Pearlstein holding as a viable one. See, e. g., Palmer v. Thomson & McKinnon Auchincloss, Inc., 427 F.Supp. 915 (D.Conn. 1977); Evans v. Kerbs, 411 F.Supp. 616 (S.D.N.Y.1976); Newman v. Pershing & Co., 412 F.Supp....