FRANKLIN SAV. BANK IN CITY OF NEW YORK v. Levy, 71 Civ. 882 (CMM).

• Decision Date: 24 December 1975
• Docket Number: No. 71 Civ. 882 (CMM).,71 Civ. 882 (CMM).
• Citation: 406 F. Supp. 40
• Parties: The FRANKLIN SAVINGS BANK IN the CITY OF NEW YORK, Plaintiff, v. Gustave L. LEVY et al., Defendants.
• Court: U.S. District Court — Southern District of New York

406 F. Supp. 40

The FRANKLIN SAVINGS BANK IN the CITY OF NEW YORK, Plaintiff, v. Gustave L. LEVY et al., Defendants.

No. 71 Civ. 882 (CMM).

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

December 24, 1975.

Thacher, Proffitt & Wood, New York City, for plaintiff; Robert S. Stitt, George W. Taliaferro, Jr., New York City, of counsel.

Sullivan & Cromwell, New York City, for defendants; William Piel, Jr., Michael M. Maney, Philip L. Graham, Jr., Charles E. Dorkey III, New York City, of counsel.

METZNER, District Judge:

Franklin Savings Bank (Franklin) filed this action against the general partners of Goldman, Sachs & Company (Goldman, Sachs), alleging violations of Sections 12(2) and 17(a) of the Securities Act of 1933, 15 U.S.C. §§ 77l(2), 77q(a), Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), the New York Martin Act, N.Y. General Business Law § 352-c, and the common law.

Goldman, Sachs is engaged in the business of investment banking, underwriting and dealing in securities. It has achieved a reputation as one of the leaders in this field. One of the areas of its activity is as a dealer in commercial paper. As used here, commercial paper is the unsecured promissory notes of well-known large financial or industrial corporations, with a maturity of less than 270 days. Goldman, Sachs held itself out as the oldest and leading commercial paper dealer in the country. It was the exclusive dealer for the sale of Penn Central Transportation Company (PCTC) commercial paper, as well as for 225 other corporations. As a dealer, it purchased the notes of an issuer for resale as principal, and held the notes in inventory just as a retailer holds stock-in-trade in inventory.

In 1968, the State of New York enacted a statute (N.Y. Banking Law § 235(12-a) (McKinney 1971)), which allowed savings banks to invest in commercial paper. The purpose of the statute was to widen the investment opportunities available to these banks to include low risk and higher interest-paying securities. In order to qualify for purchase by the bank, the paper first had to receive a prime ("the highest") rating from an independent rating service designated by the state banking board. The National Credit Office, a subsidiary of Dun & Bradstreet, Inc., was so designated.

Immediately after the adoption of this law, Goldman, Sachs wrote to the plaintiff requesting the opportunity to make a presentation of the services it could render in the purchase of commercial paper. Subsequently, purchases of such paper, issued by various companies, were made by Franklin from Goldman, Sachs.

On March 16, 1970, Harry H. Bock, plaintiff's president, called Goldman, Sachs and said that he was interested in buying 90-day commercial paper totalling $1,500,000. Goldman, Sachs offered a $1,000,000 note of the Thomas J. Lipton Company, and a $500,000 note of PCTC. Plaintiff bought both notes.

I should point out here that the Penn Central Company is a holding company whose stock was publicly owned. Penn Central owned all the stock of PCTC.

The PCTC note matured on June 26, 1970, but unfortunately, on June 21, 1970, the Penn Central System of companies, which included PCTC, filed for reorganization under the Bankruptcy Act. The note was duly tendered but payment was never received. Hence this lawsuit for damages and rescission of the sale.

The issues were developed during a nine-day trial to the court without a jury. Defendants challenge both the jurisdiction of the court and the merits of plaintiff's claim.

1. Jurisdictional Basis under Section 12(2) of the 1933 Act

Section 12(2) provides for the liability of the seller of a security under certain conditions provided that the security was offered or sold "by the use of any means or instruments of transportation or communication in interstate commerce or of the mails . . .."

Goldman, Sachs contends that there was no use of an interstate instrumentality or the mails sufficient to give jurisdiction under the 1933 Act.

The interstate telephone calls proved by plaintiff relate solely to the purchase of the note by Goldman, Sachs, as a principal, from PCTC, or to setting general sales policy. They do not involve a use of interstate facilities in connection with the sale by defendants, as principal, to this plaintiff. III L. Loss, Securities Regulation, ch. 11C at 1708 (2d ed. 1961).

The only telephone calls directly involved with the sale of this note were intrastate calls. These are insufficient for jurisdiction under the 1933 Act although sufficient under the Securities Exchange Act of 1934. United States v. De Sapio, 299 F.Supp. 436 (S.D.N.Y. 1969). See Myzel v. Fields, 386 F.2d 718 (8th Cir. 1967), cert. denied, 390 U.S. 951, 88 S.Ct. 1043, 19 L.Ed.2d 1143 (1968).

The sale in this case consisted primarily of delivery of the note and receipt of payment. Admittedly, neither of these acts was accomplished by the use of the mails. Plaintiff, after placing the purchase order, directed its agent bank, Savings Bank Trust Company, to furnish funds to Chemical Bank to pay for the purchase. The note was to be held by Chemical solely as a depository. Defendants hand-delivered the note with a confirmation slip attached to Chemical against payment in federal funds. The use of federal funds is in effect payment in cash. However, this does not end the inquiry since use of the mails after the time of the primary acts may still affect the transaction in order to bring Section 12(2) into operation.

Plaintiff relies mainly on the mailing of a confirmation slip by defendants to plaintiff after completion of the transaction. United States v. Cashin, 281 F.2d 669 (2d Cir. 1968). Defendants seek to distinguish Cashin by relying on the fact that the usual form of confirmation slip or "sales bill" was attached to the note when it was delivered to Chemical Bank, and thus the mailing was superfluous. That slip contained the discount date, the name of the purchaser, the face amount of the note, the discount rate and amount, the maturity date of the note, the net discounted price, and delivery instructions. All of this is important information since the note only revealed its face value and maturity date. The slip was a necessary document not only for the internal records of Franklin, but for the auditors of the New York State Banking Department.

Assuming that the sales slip was a confirmation slip, it is effective for its intended purpose only if it reaches the purchaser. Delivery to Chemical Bank as custodian of the note did not achieve this goal. The information still had to reach plaintiff, and that occurred here when Savings Bank Trust Company mailed the advice to Franklin. Such use of the mails was reasonably foreseeable by defendants. United States v. Wolfson, 405 F.2d 779 (2d Cir. 1968), cert. denied, 394 U.S. 946, 89 S.Ct. 1275, 22 L.Ed.2d 479 (1969); III Loss, supra, ch. 9F at 1521-28, and VI Loss, supra, ch. 9F at 3744-51. Thus, either the mailing by Savings Bank Trust Company or the mailing by Goldman, Sachs provides the jurisdictional base for the remedy provided by Section 12(2).

2. Jurisdictional Basis under Section 10(b) of the 1934 Act

The applicability of the anti-fraud provisions of Section 10(b) of the 1934 Act depends on whether this note is a security. Section 3(a)(10) of that Act states in pertinent part:

"(10) The term `security' means any note . . . but shall not include . . . any note . . . which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited." (Emphasis added.)

The note in question matured in less than nine months, but that does not end the matter. There is still the question of whether the note is of a certain type of commercial paper. Zeller v. Bogue Electric Manufacturing Corporation, 476 F.2d 795 (2d Cir.), cert. denied, 414 U.S. 908, 94 S.Ct. 217, 38 L.Ed.2d 146 (1973); Sanders v. John Nuveen & Company, 463 F.2d 1075 (7th Cir.), cert. denied, 409 U.S. 1009, 93 S.Ct. 443, 34 L.Ed.2d 302 (1972). In Zeller the court agreed with the decision in Sanders that despite the wording of the exemption, a promissory note with a maturity of less than nine months may still be a security under the 1934 Act "unless the note fits the general notion of `commercial paper' reflected in the SEC Release." Zeller, 476 F.2d at 800.

The Release referred to in Zeller is 33-4412, 17 C.F.R. § 231.4412. That Release, which dealt with the exemption of a security from the registration requirements of the 1933 Act, stated:

"The legislative history of the Act makes clear that section 3(a)(3) of the 1933 Act applies only to prime quality negotiable commercial paper of a type not ordinarily purchased by the general public, that is, paper issued to facilitate well recognized types of current operational business requirements and of a type eligible for discounting by Federal Reserve banks." 26 Fed.Reg. 9159 (Sept. 29, 1961).

Zeller holds that there is no doubt that the SEC would take the same view with respect to the exclusion provided in Section 3(a)(10) of the 1934 Act.

The record shows that these notes were issued usually in amounts of at least $500,000, with many over the million dollar mark. The record further shows that the purchasers, except in one or two instances, appear to be banks or large corporations seeking short-term investment for excess cash. Neither type of purchaser fits the definition of "general public" as used in the SEC Release, nor in the legislative history referred to in that Release. For example, the Senate Report states:

"It is not intended under the bill to require the registration of short-term commercial paper which, as is the usual practice, is made to mature in a few months and ordinarily is not advertised for sale to the general public." S.Rep.No.47 on S. 875, 73d Cong. 1st Sess. (1933) at 4.

Franklin urges that since PCTC notes were admittedly being "rolled...