Gordon & Co. v. Ross

• Decision Date: 17 May 1996
• Docket Number: No. 1625,D,1625
• Court: U.S. Court of Appeals — Second Circuit
• Parties: GORDON & CO., Plaintiff-Appellant, v. Arthur H. ROSS, Defendant-Appellee. ocket 94-9205.

Page 542

84 F.3d 542

GORDON & CO., Plaintiff-Appellant, v. Arthur H. ROSS, Defendant-Appellee.

No. 1625, Docket 94-9205.

United States Court of Appeals, Second Circuit.

Argued June 28, 1995.

Decided May 17, 1996.

Steven L. Herrick, Garden City, NY, for Plaintiff-Appellant.

Jack David, New York City (Steven Finell, New York City, of counsel), for Defendant-Appellee.

Before: VAN GRAAFEILAND, JACOBS and LEVAL, Circuit Judges.

VAN GRAAFEILAND, Circuit Judge:

Gordon & Co. ("Gordon") appeals from a judgment of the United States District Court for the Southern District of New York (Gershon, M.J.) dismissing Gordon's complaint alleging fraud against Arthur H. Ross, the former Chief Executive Officer of Hanover Square Securities Group, Inc. ("Hanover"). The judgment was based in part upon a grant of summary judgment in Ross's favor and in part upon a verdict in Ross's favor following a bench trial before Magistrate Judge Gershon. We vacate and remand to the district court for further proceedings.

At all times relevant to this action, Gordon was a broker-dealer in publicly traded securities. Its principal business was selling put and call options. If a customer exercised an option before it expired, Gordon would sell to the customer (in the case of a call) or buy from the customer (in the case of a put) a specified number of shares of a particular stock at a set price. Gordon hedged itself in these transactions by creating a margin account which held covering securities. Gordon financed its securities purchases in part by borrowing from the brokerage firm in which its margin account was maintained.

Hanover was Gordon's principal clearing broker for executing Gordon's trades on the New York Stock Exchange, and Gordon maintained a margin account with Hanover. On October 21, 1983, Gordon had securities worth approximately $13 million in this account, with a debit balance representing its borrowings against these securities in the approximate amount of $4.7 million.

On Monday, October 17, 1983, the New York Stock Exchange informed Hanover's principals that their brokerage business would be closed on Friday, October 21st unless they raised substantial capital, stopped hypothecating fully-paid securities and corrected shoddy bookkeeping practices. On the 21st, Gordon learned of Hanover's problems and attempted without success to withdraw $4.5 million from its margin account, which was the amount in excess of that needed to satisfy margin requirements. Instead of receiving the money, Gordon was asked to meet over the weekend with representatives of Hanover and other securities brokers who dealt with Hanover to explore the possibility of raising sufficient capital for Hanover to permit it to open its business on Monday, October 24th.

In the course of these meetings, Gordon agreed to loan Hanover $1,950,000 by increasing its debit balance to Hanover in this Hanover was permitted to open for business on October 24th, but did not transfer Gordon's securities, as it had promised to do. It began the transfers on October 26th, but ultimately failed to deliver $1,890,796 of fully-paid securities because, contrary to Ross's representations, it had hypothecated these securities to two banks to secure $1,034,347 in loans from the banks. In order to recover its $1,890,796 in securities, Gordon loaned Hanover an additional $1,034,347 with which to pay its bank indebtedness. On December 8, 1983, Hanover was forced to liquidate. Not surprisingly, neither loan was repaid.

                amount.   To induce the making of this loan, Hanover representatives, including Ross, promised that, if the New York Stock Exchange permitted Hanover to open on the 24th, all of Gordon's securities in Hanover's margin account would be delivered on that day to Bear Sterns, Gordon's designee, upon Gordon's payment to Hanover of the debit balance in its Hanover account.   To satisfy Gordon that this transfer was possible, Ross represented that none of Gordon's fully-paid securities in its margin account with Hanover had been hypothecated by Hanover to secure repayment of any borrowings that Hanover had made
                

In 1987, Gordon commenced this action in New York Supreme Court alleging that the fraudulent misrepresentations by Ross led to the making of both loans. After the action was removed to the Southern District of New York, it was referred by stipulation to Magistrate Judge Gershon for disposition pursuant to 28 U.S.C. § 636(c). Magistrate Judge Gershon rejected Gordon's claim based on the second loan by granting Ross's motion for summary judgment directed to that cause of action. Thereafter, she conducted a bench trial of Gordon's claim respecting the first loan, and, at the conclusion thereof, held in favor of Ross.

In the course of these proceedings, Magistrate Judge Gershon made a number of factual findings that have full support in the record. She found that Ross misrepresented that, if Gordon made the $1,950,000 loan, all of the over $13 million of Gordon's securities held by Hanover would be delivered to Gordon on October 24th, against payment by Gordon of its debit balance of approximately $4.7 million. She found that Ross also misrepresented that none of Gordon's fully-paid securities had been hypothecated for loans to Hanover, and that these misrepresentations were deliberate and material. She found that, as of November 4, 1983, Gordon could not obtain delivery of $1,890,796 of its fully-paid securities because Hanover had hypothecated them to secure loans from the two banks, and as a result, Gordon was required to pay off Hanover's loans from the two banks in the amount of $1,034,347 to free the hypothecated securities.

Gordon seeks recovery of the balance owing on both the $1,950,000 loan ("Loan # 1") and the $1,034,347 loan ("Loan # 2"). Because the issues with respect to the two loans are not identical, we discuss them separately.

Loan # 1

In denying Gordon recovery on Loan # 1, the magistrate judge focussed on the fact that Gordon's wrongfully hypothecated stock eventually was transferred to Gordon's designee. She said that "even if Ross's statements had been true, and all of Gordon & Co.'s securities had been delivered on October 24, 1983, the $1,950,000 loan would still have been outstanding." This may be an interesting hypothetical, but it is not the issue in the case. Ross's statements were not true, and the starting point for determination is whether the untrue statements induced Gordon to make the $1,950,000 loan. If they did, the issue of Ross's liability hinges upon the relationship between Ross's fraudulent statements and Gordon's loss. In analyzing this relationship, it was important that the trial judge follow the law of New York. In New York, "[a] cause of action for fraud may arise when one misrepresents a material fact, knowing it is false, which another relies on to its injury." Graubard Mollen Dannett & Horowitz v. Moskovitz, 86 N.Y.2d 112, 122, 629 N.Y.S.2d 1009, 1014, 653 N.E.2d 1179, 1184 (1995); see also Barclay Arms, Inc. v. Barclay Arms Assocs., 74 N.Y.2d 644, 646-47, 542 N.Y.S.2d 512, 514, 540 N.E.2d 707, 709 (1989) (no fraud where, inter alia, plaintiff did not rely on misrepresentation); Orbit Holding Corp. v. Anthony Hotel Corp., 121 In Channel Master Corp. v. Aluminium Ltd. Sales, Inc., 4 N.Y.2d 403, 407, 176 N.Y.S.2d 259, 151 N.E.2d 833 (1958), the Court, citing 3 Restatement, Torts, § 525, at 59, said:

A.D.2d 311, 314, 503 N.Y.S.2d 780, 782 (1986) (final element of fraud is showing "that the party to whom the representation was made relied upon it to its injury or damage").

Accordingly, one "who fraudulently makes a misrepresentation of * * * intention * * * for the purpose of inducing another to act or refrain from action in reliance thereon in a business transaction" is liable for the harm caused by the other's justifiable reliance upon the misrepresentation.

Sections 546 and 548A of the Restatement (Second) of Torts also emphasize the importance of reliance:

§ 546. Causation in Fact

The maker of a fraudulent misrepresentation is subject to liability for pecuniary loss suffered by one who justifiably relies upon the truth of the matter misrepresented, if his reliance is a substantial factor in determining the course of conduct that results in his loss.

§ 548A Legal Causation of Pecuniary Loss

A fraudulent misrepresentation is a legal cause of a pecuniary loss resulting from action or inaction in reliance upon it if, but only if, the loss might reasonably be expected to result from the reliance.

Obviously then, in New York, as in any other state whose common law accords with the view of the Restatement, liability is determined by whether the plaintiff justifiably relied upon the defendant's misrepresentations and suffered a loss that reasonably might have been anticipated to result from the reliance. See Manufacturers Hanover Trust Co. v. Drysdale Sec. Corp., 801 F.2d 13, 20-21 (2d Cir.1986), cert. denied sub nom. 479 U.S. 1066, 107 S.Ct. 952, 93 L.Ed.2d 1001 (1987); Marbury Management, Inc. v. Kohn, 629 F.2d 705, 708 (2d Cir.), cert. denied sub nom. 449 U.S. 1011, 101 S.Ct. 566, 66 L.Ed.2d 469 (1980).

Gordon's claim of recoverable damage with regard to Loan # 1 is not based upon the difficulties it encountered in securing the return of its wrongfully hypothecated securities. It is based on the contention that Gordon would not have made the loan if Ross had not deceived it concerning Hanover's stock machinations. In paragraph 21 of Gordon's amended complaint, it alleged that "[t]o induce plaintiff to close and consummate the Cash Subordination Agreement," (the $1,950,000 loan) Ross represented that Hanover would promptly return Gordon's securities. In paragraph 25, Gordon alleged that it relied upon this representation "by consummating and closing" the Cash Subordination Agreement. In paragraph 26, Gordon alleged that no part of the subordinated loan had been repaid except $31,145.34 in interest.

We...