Evans v. Kerbs and Co., 74 Civ. 5621 (JMC).

• Citation: 411 F. Supp. 616
• Decision Date: 02 March 1976
• Docket Number: No. 74 Civ. 5621 (JMC).,74 Civ. 5621 (JMC).
• Parties: Charles F. EVANS, Jr., Plaintiff, v. KERBS AND COMPANY, a partnership, et al., Defendants.
• Court: U.S. District Court — Southern District of New York

411 F. Supp. 616

Charles F. EVANS, Jr., Plaintiff, v. KERBS AND COMPANY, a partnership, et al., Defendants.

No. 74 Civ. 5621 (JMC).

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

March 2, 1976.

COPYRIGHT MATERIAL OMITTED

Charles F. Evans, Jr., pro se.

Willkie, Farr & Gallagher, New York City (Louis A. Craco, Richard L. Feller and Michael B. Targoff, New York City of counsel), for defendant Hardy & Co.

Rosner, Rosner & McEvoy, New York City (Andrew T. McEvoy, Jr., New York City, of counsel), for defendants Kerbs and Company, Edward Kerbs and John Kerbs.

Milbank, Tweed, Hadley & McCloy, New York City (Russell E. Brooks, New York City, of counsel), for defendant New York Stock Exchange, Inc.

OPINION

CANNELLA, District Judge:

Plaintiff Charles F. Evans, Jr. (Evans) brings this action against Hardy & Co. (Hardy), Kerbs and Company (Kerbs), Edward Kerbs, John Kerbs and the New York Stock Exchange, Inc. (NYSE or the Exchange) for claims arising from their alleged violation of the margin and anti-fraud provisions of the federal securities laws.¹ Plaintiff seeks rescission of certain stock transactions executed through defendants Hardy and Kerbs, and damages for losses said to have resulted from the claimed violations. Defendants Edward and John Kerbs are sued as partners of Hardy & Co. and Kerbs and Company. The broker defendants, Hardy and Kerbs, move to dismiss pursuant to Rules 12(b)(1) and (6) of the Federal Rules of Civil Procedure. Defendant NYSE similarly moves to dismiss, and in the alternative makes a motion for summary judgment pursuant to Rule 56, Fed.R.Civ.P. These motions are denied.

THE COMPLAINT

At this stage of the proceedings the following allegations of plaintiff's complaint must be deemed true:

Defendants Hardy and Kerbs, both members of the New York and American Stock Exchanges, were partnerships organized under the laws of New York and doing business as securities brokers-dealers. Beginning in 1962, Kerbs maintained both margin and cash accounts for the purchase and sale of securities on plaintiff's behalf. Sometime during 1967 Kerbs transferred plaintiff's accounts to defendant Hardy and thereafter and until February 28, 1973 Hardy cleared plaintiff's stock transactions originating through Kerbs.² Evans' registered representative at Kerbs during this period was John Sheehy, whom he relied on for investment information and advice.³

Immediately prior to and during the period between December 23, 1971 and November 30, 1972, Sheehy informed Evans that it would be advisable to invest any available capital in equity securities and to maximize his potential return thereon through margin borrowing to the extent permitted by law. Furthermore, Sheehy advised that Evans take greater positions in fewer stocks. Evans followed these suggestions. Sheehy also informed plaintiff that the regulations applicable to these transactions required the maintenance of no greater than 25 percent margin in his account. This meant that if Evans chose to trade on margin, he must always have equity in his account equal to at least twenty-five percent of the market value of his securities. These minimum permissible margin maintenance levels are set by New York Stock Exchange Rule 431 and American Stock Exchange Rule 462.⁴

Evans contends that insofar as certain of his holdings were subject to unusually rapid or violent changes in value or held in such amounts that they could not be liquidated promptly, the applicable provisions of Rules 431 and 462 were not the minimum requirements contained in subsection (b)(1), but the additional margin requirements of subsection (d)(1). It is further alleged that the broker defendants, at all times relevant herein, were aware that these latter regulations requiring that plaintiff maintain a margin level substantially greater than twenty-five percent in his account were applicable, but did not communicate this information to him. In fact, he did not learn of the existence of these rules until January of 1974.

Beginning in December of 1972 and continuing thereafter the amount of margin in plaintiff's account fell below that allegedly required by NYSE Rule 431 and AMEX Rule 462. However, plaintiff did not receive a request for additional margin until on or about January 30, 1973, when the margin in his account had declined below twenty-five percent. At that time, plaintiff was advised that the sale of any securities then in his margin account would be likely to depress their market price even further, resulting in the elimination of all margin and plaintiff's equity in the account.⁵ Consequently, he attempted to meet the margin call by depositing his remaining liquid assets with Hardy.

The market values of plaintiff's securities continued to decline and, on February 28, 1973, when plaintiff's equity in the account had dipped to nine percent, Hardy began liquidating the account. Due to the nature of the market for plaintiff's securities, liquidation had not been completed by the commencement of the instant action on December 20, 1974. However, plaintiff did not receive any additional requests for margin until August 2, 1974.

With respect to the New York Stock Exchange, the complaint alleges that sometime during the latter half of 1972 the Exchange, while reviewing plaintiff's account with Hardy, discovered that the account was either undermargined or in danger of becoming undermargined in violation of NYSE Rule 431 and communicated this to defendant Hardy. However, NYSE failed to follow up its warning to ascertain whether any remedial action had been taken in connection with plaintiff's account. As a result, the account remained in violation of Rule 431 until liquidation began on February 28, 1973.

DISCUSSION

Contrary to defendants' assertion, plaintiff's claim is not premised upon the broker defendants' failure to liquidate his margin account promptly after a decline in market value of the stock held in the account caused the equity in the account to fall below the minimum requirement of the stock exchange rules, a claim insufficient under the law of this circuit. See Shemtob v. Shearson, Hammill & Co., 448 F.2d 442 (2d Cir. 1971). The complaint, construed in the light most favorable to plaintiff, states the following claim: Evans, having been induced to maintain a margin account with the broker defendants, was injured by their intentional misstatement of and failure to apply the appropriate maintenance margin requirements under the federal securities laws and stock exchange rules.

In essence, the issue presented is whether an implied private right of action is available to an individual investor for an alleged violation of NYSE Rule 431 and AMEX Rule 462 by a securities broker or dealer. The Court finds that under the facts contained in the instant complaint, such an action is maintainable.

There is no question that an implied federal right of action exists for violations of certain provisions of the federal securities laws. See J. I. Case Co. v. Borak, 377 U.S. 426, 84 S.Ct. 1555, 12 L.Ed.2d 423 (1964); Colonial Realty Corp. v. Bache & Co., 358 F.2d 178 (2d Cir.), cert. denied, 385 U.S. 817, 87 S.Ct. 40, 17 L.Ed.2d 56 (1966); Baird v. Franklin, 141 F.2d 238 (2d Cir.), cert. denied, 323 U.S. 737, 65 S.Ct. 38, 89 L.Ed. 591 (1944). This judicial recognition "of a private remedy not expressly afforded by the Securities Exchange Act is predicated on the duty of the courts `to make effective the congressional purpose' represented in `the statute and the federal policy which it has adopted.'" Colonial Realty Corp., supra at 181, quoting from J. I. Case v. Borak, 377 U.S. 426, 433, 84 S.Ct. 1555, 1560, 12 L.Ed.2d 423, 428 (1964). This is a consequence of the doctrine that violation of a legislative enactment by doing a prohibited act may render a party liable to a private individual where the intent of the act is to afford protection to the interest of another and that interest is in fact invaded.⁶

Whether such a claim can be maintained for violation of stock exchange rules is a more difficult problem, as the effect and significance of particular rules will vary with their relationship to the provisions and purposes of the securities laws and the regulations promulgated thereunder. In this area the Court of Appeals for the Second Circuit has formulated the following rule to be applied when determining whether violation of a particular stock exchange rule will give rise to an implied private right under the federal securities laws.

What emerges is that whether courts are to imply federal civil liability for violation of exchange or dealer association rules by a member cannot be determined on the simplistic all-or-nothing basis urged by the two parties; rather, the court must look to the nature of the particular rule and its place in the regulatory scheme, with the party urging the implication of a federal liability carrying a considerably heavier burden of persuasion than when the violation is of the statute or an SEC regulation.

Colonial Realty Corp., supra, at 182. Applying this analysis, federal courts have found that certain stock exchange rules play an integral part in Securities and Exchange Commission and Federal Reserve Board regulation for protection of the public, Hayden v. Walston & Co., 528 F.2d 901 (9th Cir. 1975); Van Gemert v. Boeing Co., 520 F.2d 1373 (2d Cir. 1975); Securities and Exchange Comm'n v. First Securities Co., 463 F.2d 981 (7th Cir.), cert. denied, 409 U.S. 880, 93 S.Ct. 85, 34 L.Ed.2d 134 (1972); Avern Trust Co. v. Clarke, 415 F.2d 1238 (7th Cir. 1972); Buttrey v. Merrill Lynch, Pierce, Fenner & Smith, 410 F.2d 135 (7th Cir.), cert. denied, 396 U.S. 838, 90 S.Ct. 98, 24 L. Ed.2d 88 (1969); Colonial Realty Corp., supra, and will consequently support a private right of action. Van Gemert, supra at 1380-81; Ocrant v. Dean Witter & Co., Inc., 502 F.2d 854, 858 (10th Cir. 1974); Buttrey, supra; Colonial Realty Corp., supra.⁷

With this in mind, we...